Thursday, February 5, 2015

The Future of Interest Rates

Popular Economic Weekly

The stock market plunged yesterday, but interest rates plunged as well with the latest Fed FOMC meeting and press release. Traders felt that the Fed Governors were being too optimistic about America’s economic outlook in 2015. The first estimate of Q4 GDP growth was 2.6 percent, disappointing those who saw slower growth ahead after Q3’s 5 percent GDP growth rate. So we believe the Fed will put off its mid-summer rate hike, leaving rates at record lows for the rest of 2015.

It is exactly when interest rates begin to rise that is confusing both markets and consumers. With consumer confidence now above pre-recession levels (thanks to very low gas prices) and in a spending mood, now wouldn’t be the time to announce upcoming rate hikes, and the Federal Reserve knows that.


Graph: Econoday

“The Committee continues to see the risks to the outlook for economic activity, said the press release, “and the labor market as nearly balanced. Inflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate. The Committee continues to monitor inflation developments closely.”

But wait a minute. There was nothing in the words that said it couldn’t be later in the year, since inflation is still falling, and wages aren’t rising for most consumers. Consumers power some 70 percent of economic activity, so a rise in their borrowing rates on autos and consumer goods could stop spending on a dime. And that’s just what the main body of its press release intimated.

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely (my emphasis), if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”

The housing market in particular wants to keep interest rates as low as possible to lure more buyers into the housing market. But there is still much uncertainty. For instance, the NAR’s Pending Home Sales index fell slightly in December, even though new-home sales jumped 11.6 percent.

The Pending Home Sales Index, a forward-looking indicator based on contract signings, decreased 3.7 percent to 100.7 in December from a slightly downwardly revised 104.6 in November, said the NAR’s press release, but is 6.1 percent above December 2013 (94.9). Despite last month’s decline (the largest since December 2013 at 5.8 percent), the index experienced its highest year-over-year gain since June 2013.

Lawrence Yun, NAR chief economist, says fewer homes available for sale and a slight acceleration in prices likely led to December’s decline in contract signings. “Total inventory fell in December for the first time in 16 months, resulting in fewer choices for buyers and a modest uptick in price growth in markets throughout the country,” he said. “With interest rates at lows not seen since early 2013, the strength in existing-sales in upcoming months will largely depend on the willingness of current homeowners to realize their equity gains from the past couple years and trade up.”

Raising rates too soon just happened in Japan. It had raised its value-added tax late last year, and Japan’s consumers stopped buying. Probably because Prime Minister Abe listened to his bankers rather than the economists, and bankers tend to worry about inflation even when there is none. Japan had endured more than 2 decades of deflation, which had reduced everyone’s incomes. It can take another decade to fix their pocketbooks, and business profits, as well.

So I believe the Fed will be reluctant to raise rates at all until the inflation rate rises from its current low, since that is a sure sign that consumers won’t pay more for things, because they can’t.

Harlan Green © 2015

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