The Bigger Question Behind Interest Rates
What If Fed Cuts Don’t Make Money Cheap Again?
That possibility matters if you own real estate, use leverage, invest in private deals, or are simply waiting for lower rates to make the numbers work again.
For the last several years, investors have been watching the Federal Reserve and asking some version of the same question:
When are they going to cut?
The assumption is pretty straightforward.
Inflation rises, the Fed raises rates and borrowing gets more expensive.
Eventually inflation falls, the Fed cuts rates, and borrowing gets cheaper again.
But there’s a problem with that assumption.
The Fed does not control all interest rates.
It controls short-term rates. The longer end of the bond market—the 10-, 20-, and 30-year yields—is ultimately driven by investors deciding what they require to lend money for that long.
And those investors may be starting to ask a different question:
How much do I need to be paid to lend money to a government running trillion-dollar deficits and refinancing an enormous pile of debt?
U.S. Treasury debt—bonds, notes, and bills—has essentially been considered the world’s “risk-free” asset. Most believe the U.S. government won’t default on its obligations.
But at some point, bond investors can still say:
“I’ll lend you the money. But given your deficits, increasing debt, inflation risk, and the likelihood that future dollars will purchase considerably less, I need to be paid more.”
That is what a repricing of sovereign debt means.
And this is where it gets interesting for investors.
We could see the Fed cut short-term rates while 10-, 20-, and 30-year yields remain stubbornly high—or even move higher.
If that happens, the bond market may be telling us the problem isn’t simply today’s inflation rate. It may be something deeper around government fiscal overspending.
So what does this mean for us as investors?
Here’s my take.
We’ve lived through an extraordinary period in which falling interest rates, abundant liquidity, and expanding asset valuations rewarded leverage and made many mediocre investments look much better than they actually were.
That environment may not return anytime soon.
If that’s true, several principles become increasingly important.
Don’t Try to Predict the Fed
Build a portfolio that doesn’t require your forecast to be right.
I don’t know whether we’re witnessing the beginning of a genuine global repricing of sovereign debt.
Neither does anyone else.
But we don’t have to know.
Our job isn’t to perfectly forecast interest rates, inflation, the dollar, gold prices, or the next recession.
Our job is to build enough resilience into our financial lives that we don’t need the forecast to be right.
Keep Liquidity
Cash is not dead money – it’s optionality when opportunities appear.
Cash isn’t just an asset earning a yield. It’s the ability to act when other people cannot.
There are times when maintaining liquidity and waiting for a better risk-adjusted opportunity is doing something.
That can be difficult for successful business owners and investors to accept. We’re used to action. We’re used to putting capital “to work.”
But there are seasons when liquidity creates margin.
And margin creates choices.
Be Careful With Leverage
Cheap refinancing can no longer be assumed.
An investment that only works with cheap refinancing or aggressive growth assumptions isn’t particularly resilient.
Leverage can improve returns when things go well. It can also magnify problems when capital gets more expensive, exits get delayed, or assumptions fail to materialize.
The question is not simply, “What does this investment return if the plan works?”
It is also, “What happens if financing remains expensive longer than expected?”
[More on this topic in this article: “When Are You Over Leveraged?”]
Prioritize Real Cash Flow
Be wary of investments dependent on appreciation or the next buyer paying more.
I’d rather own an asset that pays me based upon today’s economics than one whose success depends upon tomorrow’s buyer paying substantially more.
That doesn’t mean appreciation doesn’t matter. It means I don’t want appreciation to be the only reason the deal works.
Falling interest rates and expanding valuations made a lot of investments look better than they really were.
Real cash flow gives you something tangible while you wait.
Know Your Duration
Assume capital could remain tied up longer than projected.
How long is my capital committed?
What happens if the exit takes two years longer than projected?
What happens if refinancing becomes difficult?
What happens if the market simply isn’t willing to pay the price the original underwriting assumed?
Duration matters because time can turn a good investment into a difficult one when liquidity disappears.
Know Your Counterparty
Character, experience, and behavior during difficult markets matter.
Who am I trusting my capital to?
How have they behaved when conditions became difficult—not just when everything was going up?
What does communication look like when the plan changes?
How do they make decisions under pressure?
Almost anyone can look good in a rising market.
Difficult markets tell you much more about who you are investing alongside.
Be Patient
You don’t have to keep every dollar deployed.
Look, you don’t have to swing at every pitch.
Sophisticated investors sometimes suffer from a peculiar problem: feeling as if we should always be doing something.
- Deploying capital.
- Finding the next deal.
- Increasing yield.
- Putting cash money “to work.”
But there are seasons when maintaining liquidity and waiting for a better risk-adjusted opportunity is doing something.
We don’t receive bonus points for keeping every dollar continuously deployed.
Patience is an investment strategy.
I’ve lived through enough market cycles to know that the best opportunities rarely arrive when everybody feels comfortable.
They tend to appear after something has broken, when capital becomes scarce, and people who previously thought liquidity was inefficient suddenly desperately need it.
That’s when optionality becomes valuable.
That’s when having margin matters.
More importantly, uncertainty isn’t necessarily something we need to eliminate.
Sometimes uncertainty creates the very opportunities we’re waiting for.
[More on this in my Dental Economics article: “9 ways dentists can maintain financial stability for retirement“]
The question is whether we’ll have the liquidity, patience, and conviction to act when they arrive—or whether we’ll have already committed our capital, overextended ourselves, or built a portfolio that only works if our forecast is right.
