There is high anxiety in the financial markets about rising interest rates. Many analysts fear that consumers will suffer, especially given the recent popularity of adjustable rate mortgages (ARMs). But with short-term interest rates catching up to long rates, most Americans shouldn't feel much pain.
The increase in interest income received by Americans on their assets this year is set to exceed additional interest costs for the first time since 2000. According to JPMorgan Chase (JPM) economists Robert Mellman and Bruce Kasman, higher rates should translate into $65 billion more in interest payments on all forms of debt in 2006 compared with 2005. At the same time, consumers should earn close to $73 billion more in interest income.
The flattening yield curve is a positive for many consumers. The Federal Reserve has lifted its federal funds rate by 325 basis points, to 4.25%, since June, 2004. But Americans hold far more assets, including savings accounts and certificates of deposit, that are linked to short-term interest rates than they do liabilities such as credit-card debt. With the Fed expected to raise rates a bit more this year, interest income should accelerate.
At the same time, concerns that the Fed's tightening would punish the historically large number of homeowners who have opted for ARMs remain premature. In 2006 nearly $320 billion of about $2 trillion in outstanding single-family ARM loans are set to readjust. If the entire $320 billion were refinanced into fixed-rate mortgages -- a fair assumption with the recent reset rate at 7%, vs. 6.25% for a fixed-rate mortgage -- annual interest costs would rise by $4.75 billion, the Morgan economists calculate. But if none of the ARMs set to float this year were refinanced, net interest income would still be positive.
This year's gains in interest income are coming at an important time. The positive change in net interest will provide consumers with some additional funds to fuel spending just as the housing market, the most recent engine of consumer spending growth, is expected to wind down.
By James Mehring in New York