How Low Will Interest Rates Go? – June 2019
Do you ever feel as though you are being asked to do too much? And no matter how hard you work or how much you do, you are told you could do things better?
I think the Fed must be feeling the heat. [1]
The current administration went apoplectic last week when the Fed decided not to lower the Fed Funds rate.
The current Fed Funds rate is 2.37%. A year ago, it was 1.90%. The administration wants the Fed to lower the Fed Funds rate by 1%. That would be 1.37%.
I say, “Hey, you can’t have it both ways.”
Either the economy is doing great because unemployment is low, inflation is low and for a blip of a second, we saw GDP at 4%.
Or the economy isn’t doing so great because despite low unemployment and low inflation growth has backed off from 4% to 2.5%.
You can’t say the economy is great and then pound the Fed to lower rates.
When the Fed Funds rate starts heading to 1% something has happened to slow growth. Something like a tech bubble or a housing bubble or a 1929 style crash.
Lowering rates is a monetary policy tool the Fed can use to stimulate the economy.
Is that the message from the administration? The economy is ready to tank so we need to start stimulus now.
So back to my original point , you can’t have it both ways.
One day in June the 10-year treasury dipped below 2% . If rates are going down without help from the Fed, there must be a reason.
Investors do not like uncertainty. The ongoing trade wars are one reason (not the only reason) and as a result investor are fleeing to the relative safety of the bond markets.
As more investors buy bonds, the price of bonds goes up just like any other scarce commodity. As bond prices go up , interest rates go down.
Lower rates have a direct impact on the value of the dollar and in turn, trade with other countries. Oops. Lower rates , and this is a gross generalization , tend to weaken a currency.
If the dollar becomes weaker relative to other currencies it makes imports for us more expensive.
It means we have to use more dollars to buy stuff from China. I don’t think this is the intended outcome. So Chinese imports become more expensive . Expensive means prices going up , prices going up means inflation.
If you want a strong dollar rates need to go up, not down.
The Fed as an independent organization can only do so much. The mandate of the Fed is to use monetary policy tools to achieve full employment and keep low inflation.
So how much can the Fed do if the markets are pushing rates down for reasons out of their control?
The Fed has to anticipate what is likely to happen not exactly what is going to happen .
For example, how likely is it the economy will go into a recession ?
Back to you the investor.
There are benefits for you when interest rates drop.
One benefit from lower long-term rates is the opportunity for homeowners to refinance . Refinance applications have increased significantly over the last month.
Lower rates also help first time home buyers.
Interest rates for big purchases like cars, home appliances and electronics should be favorable. Notice I say should be.
On the other hand, low interest rates contributed to the housing bubble and one of the longest recessions in US economic history.
No one wants to go there again.
What is the Fed Funds rate?
The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services. [2]
What does it mean that the Federal Reserve is “independent within the government”?
The Federal Reserve, like many other central banks, is an independent government agency but also one that is ultimately accountable to the public and the Congress. The Congress established maximum employment and stable prices as the key macroeconomic objectives for the Federal Reserve in its conduct of monetary policy.
The Congress also structured the Federal Reserve to ensure that its monetary policy decisions focus on achieving these long-run goals and do not become subject to political pressures that could lead to undesirable outcomes. So, members of the Board of Governors are appointed for staggered 14-year terms and the Board chair is appointed for a four-year term. Elected officials and members of the Administration are not allowed to serve on the Board.
The Federal Reserve does not receive funding through the congressional budgetary process. The Fed’s income comes primarily from the interest on government securities that it has acquired through open market operations. Other sources of income are the interest on foreign currency investments held by the Federal Reserve System; fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and interest on loans to depository institutions. After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury. [3]
[1] The Fed is the Federal Open Market Committee, also known as the FOMC
[2] https://www.federalreserve.gov/monetarypolicy/fomc.htm
[3] https://www.federalreserve.gov/faqs/about_12799.htm
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