Why Interest Rates Should Finally Increase This Year; Or Not
INTEREST RATES PLUMMET AFTER 2008 MELTDOWN
After the 2008 meltdown, mortgage interest rates plummeted from the mid 6% range all the way down to the low 3% range at various times. More recently, mortgage rates have hovered in the 4% range.
Over the last ten years, I have repeated pundit predictions of imminent rate increases about a hundred times (give or take) but they never materialized for a variety of reasons (primarily weak economic conditions).
WHY 2018 IS DIFFERENT
2018, however, looks like the year when interest rates will finally increase.
Fed Is Unwinding Its Balance Sheet. Through “Quantitative Easing” (the Fed’s massive bond buying program), the Fed grew its balance sheet to almost $4.5 trillion dollars. This massive buying program held rates much lower b/c it created artificial demand for U.S Treasuries and Mortgage Backed Securities. More demand for bonds pushes prices higher and this in turn lowers rates.
The Fed has not only stopped buying bonds, but it is now selling bonds to “unwind” its balance sheet. So, not only do we have less demand for bonds, we actually have more supply.
Fed Is Raising Short Term Rates. The Fed is finally following through with its commitment to raise the short term Fed Funds rate, with four increases over the last 13 months and several more slated for 2018. The Fed made noises in the past about raising rates, but often backed off citing weak economic conditions.
Inflation. The Fed (and everyone else) is terrified of inflation, particularly b/c of the way it ravaged our economy in the 1970s. There have been signs recently that inflation may be resurfacing. One of the ways to fight inflation is to tighten the money supply by raising rates through various tools.
WHY 2018 MAY NOT BE DIFFERENT
While rates will rise in 2018, there are are several factors that might slow or stop the pending increases.
“Dovish” Fed Chairperson. A new Fed Chairperson (Jerome Powell) takes the reigns on Feb 3rd. He has been with the Fed since 2012 and has sided with the “doves” in almost all cases. “Doves” contrast with “hawks,” in that they favor lower rates and looser monetary policy.
America Can’t Afford Higher Rates/Recession Fears. Largely b/c of the low rates over the last ten years, the United States has more debt overall (Federal, State, Corporate, Consumer) than ever before. If rates increase too quickly, governments, consumers and businesses will not be able to afford to service their debt. The Fed is aware of this and will scale back on its efforts to push rates up if they sense a threat to the economy.
Weak Dollar Goals. The Trump administration has indicated that it would like to keep the dollar weaker in order to make American exports more competitive. This could have the effect of keeping rates lower too, for a variety of reasons.
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