Municipal Bond Interest Rates

What determines the level of interest rates?

The Business Cycle

As economic activity increases, so does the demand for borrowing and the interest rate. Financial institutions and capital markets alike compete for a limited supply of funds. In turn, banks raise the rates they are willing to pay to lenders as well as the interest rates for borrowers. Interest rates on investments such as municipal bonds must therefore rise to attract more capital. This process is known as the business cycle. Historical trends show us that interest rates are at their peak just as economic growth is beginning to decline. Financial analysts and investors alike are always trying to predict the business cycle in order to get a leg up on where the interest rate will go next.

The Federal Reserve

Also known as the “Fed”, the Federal Reserve Bank is America’s central bank. It holds sway over primary interest rates and has the power to either raise or lower the discount rate is charges to lend money to member banks. The Fed also has the power to add or subtract from the nation’s entire money supply. Needless to say, every investor and financial firm out there is keeping a close eye on the Fed.

Inflation

Inflation has historically been directly related to interest rates; increase inflation and interest rates increase. Anyone involved in any sort of investment involving interest must therefore be on the lookout for which direction inflation is heading. In doing so, they may hope to predict the future level of interest rates, albeit only likely in the short-term.