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Why Warren Buffett thinks interest rates exert a huge gravitational pull on asset values


The Federal Reserve sent a strong signal this week that interest rates will stay higher for longer. None other than Warren Buffett has argued that the Fed’s tighter monetary policy has a significant impact on every single investment. “Interest rates are to the prices of all assets like gravity is to the function of the earth,” the Berkshire Hathaway CEO said in a 2012 interview. “Everything is based off interest rates… It’s a huge, huge, huge gravitational pull and affects what I’m doing.” After keeping rates near zero for most of the past 15 years, the world’s most powerful central bank embarked on its most aggressive campaign to lift borrowing costs since the 1980s in order to fight stubbornly high inflation. The fed funds rate is now in a targeted range between 5.25%-5.5%, the highest in some 22 years. Buffett, the so-called “Oracle of Omaha,” believes that when interest rates are low, they make any stream of earnings from investments worth more. Conversely, a sharp rise in rates effectively lowers the present value of any future earnings. “The most important item over time and in valuation is obviously interest rates,” Buffett once said. Under the time value of money theory , stock prices are supposed to reflect the present value of a company’s future cash flows and profits. Investors use a rate based on prevailing benchmark interest rates to “discount” future dollars to the present. The higher the interest rate, the less that future money is worth today; lower rates heighten the value of future cash flows. Short-term Treasurys are “the yardstick against which other values are measured,” Buffett said during Berkshire’s annual meeting in 2021. “If I could reduce gravity’s pull by about 80%, I’d be in the Tokyo Olympics jumping. You’ve had this incredible change in the valuation of everything that produces money.” On the front end of the Treasury curve, short-term yields including six-month and one-year rates, have all surpassed 5% this year for the first time since 2007. The benchmark 10-year Treasury yield sits just below 4.5%. Rising yields could dent the appeal of all risk assets as shorter-dated Treasury bills and longer-dated Treasury notes are now a risk-free alternative offering solid yields. Additionally, investments overall tend to slow down as borrowing costs increase. Buffett stood out as one of the most prominent investors able to take advantage of higher rates, thanks to Berkshire’s mountain of cash — $147 billion at the end of June. His massive cash pile, which had been an area of concern when rates were near zero, is now earning Berkshire a substantial return with short-term rates topping 5%.

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