When the economy recovers, interest rates will go up, right?
That’s been the Federal Reserve Board’s line for years now. Yet as the Fed gushes about an allegedly booming economy, some are saying that interest rates are unlikely to increase this year.
So what gives?
Last week’s Federal Open Market Committee Statement, which summarizes monetary policy, noted that since the FOMC’s December meeting, “the economy has been expanding at a solid pace.” The statement notes that the unemployment rate is declining, consumer spending is increasing and, if not for that troublesome housing market, everything would be just dandy.
As if to put an exclamation point on the FOMC statement, Fed Chair Janet Yellen met with Congressional Democrats last week to reiterate just how fine the economy is doing. (The real purpose of the meeting may have been to explain the FOMC statement to members of Congress, as it contains phrases such as, “underutilization of labor resources continues to diminish;” which could have been worded more clearly by saying, “Many former middle managers are still working as greeters at WalMart.”)
Interest Rate Expectations Shifting
Yet, in spite of the glorious recovery, not everyone expects interest rates to rise soon. ZIRP, or “zero interest rate policy,” has been with us for years and some believe it will continue through 2015.
Economists at Morgan Stanley, for example, are acting like the Chicago Cubs and saying, “Wait until next year.”
That’s a shift from previous expectations of rates rising this summer, which is a song virtually all pundits previously were singing in unison.
Readers of our newsletter, also called Wenning Advice, may have noticed the following paragraph: “Some experts predict rates will increase in March. Others are sticking with the frequently voiced belief that they will increase this summer. However, logic indicates that they are unlikely to increase until 2016.”
To our knowledge, the economists at Morgan Stanley are not readers of Wenning Advice, but last week they pushed back their forecast for the first rate hike to March 2016 “because of the factors holding inflation down.”
Many still think that rates will rise this summer, but the Fed’s desire to boost inflation is just one reason why they may not. There are others:
Patience. In the FOMC statement, Chair Yellen said, “the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” The last time Ms. Yellen used the word “patient,” it was like the second coming of quantitative easing – the markets jumped. Of course, saying “can be patient” is not the same as saying “will be patient,” but considering the Fed took three months to come up with the word, it’s good to see Ms. Yellen getting her money’s worth out of it. (Sorry for the cliché, but it’s most appropriate when discussing the Fed.)
The World’s a Mess. As we’ve pointed out many times, economies in the rest of the world are making the U.S. look good. QE, currency games and other tactics are being used to manipulate markets and boost economies. If U.S. interest rates are too far out of synch with those of the rest of the world, it could have a negative impact on both the economy and the stock market.
When rates increase, they are expected to be raised gradually to minimize the impact. If U.S. rates increase while rates are falling in the rest of the world, the impact would be more dramatic, as the spread between U.S. rates and other rates would be more pronounced.
The U.S. Economy is Still a Mess. When the U.S. Bureau of Economic Analysis estimated that U.S. gross domestic product expanded by 5% in the third quarter, many cheered that, at last, the economy had fully recovered from the Great Recession. But growth for the fourth quarter fell back to an estimated 2.6%.
“The GDP number is a little weaker, so it may give the Fed some pause as far as raising rates,” said Jeff Kravetz, regional investment strategist at US Bank Wealth Management.
The stock market has been volatile recently and last week fell on mixed news about the U.S. economy and corporate profits.
The Keynesians are Still in Charge. The budget cuts from sequestration have helped push the annual federal budget deficit down from more than $1 trillion to a little less than half that amount. This week, though, President Obama announced that he will ask Congress to boost spending by 7% above what the “mindless budget cuts” allow (Note: sequestration was President Obama’s idea).
More government spending and easy money policies together are the Keynesians’ answer to any economic problem. Higher interest rates, of course, also increase the cost of servicing the federal debt, so if both interest rates and spending increase, it could quickly get out of control; oh wait … it’s already out of control. The cost of servicing the federal debt for 2014 was $430,812,121,372.05.
So will interest rates increase this year? Don’t bet on it.