As we look around at all the craziness in the world today, a common question is: “WWJD?” No, I’m not referring to the rubber bracelets from early 2000s. Instead, I’m talking about economics, where the appropriate question is: “What would Janet do?” That is, Federal Reserve Chair, Janet Yellen.
Greece is broke, and so is Puerto Rico. Illinois can’t pass a budget, and Chicago is bumping up against pension payments it can’t possibly make.
The U.S. economy is creating some jobs, but wages remain sluggish at best. That casts a cloud over the much-hyped-but-not-quite-here-yet boom in housing millennials will eventually lead. Right now they can hardly scrape together enough dough for a 3% down payment, much less earn enough to qualify for a conforming loan. It’ll be a long time before they rush headlong into the housing market.
So as we get closer to the Fed’s September meeting, our current situation has a lot of people wondering what in the world Janet and Company will do. Personally, I’m not too concerned.
Don’t get me wrong. It’s not that I think everything is fine. I’m just as concerned about our economic plight – or more so – than most people I know. But I think the hype around the Fed raising rates is overdone.
Eventually the Fed will announce that its target for the Fed Funds Rate – the rate at which banks lend to each other overnight – is moving up from a range of 0% to 0.25%, to simply 0.25%.
This will affect hedge funds, pension funds, insurance companies, and other institutions that use short-term leverage to increase their buying power. But aside from slightly increasing what banks pay on deposits, the move won’t mean much to everyday people. Most of us don’t live in that rarified air.
Closer to home is what happens with longer-term interest rates, like those on 5-year and 30-year Treasury bonds – and even there I think very little will happen.
That’s because interest is supposed to pay lenders (bond buyers) for the use of their money, compensate them for inflation, and provide some degree of security against the risk of non-payment.
Right now money is not in high demand. Lenders don’t get paid much to put their money to work, as any bond buyer already knows. As for inflation, I’ve written about how it’s creeping up in certain areas of the economy like health care, education, and food costs, but overall most developed nations are trying to fight deflation, not inflation. Then in regards to security, the Fed can print money to buy U.S. government bonds, so buyers have zero risk of non-payment.
In addition to all that, there are a lot of other reasons for interest rates on notes and bonds that mature in more than a year to remain quite low – tens of billions of reasons, and they are flowing from overseas!
Currently the European Central Bank (ECB) and the Bank of Japan (BoJ) are printing enough currency to buy all the new government bonds issued by all the countries of the euro zone, Japan, the U.K., and the U.S. combined.
Now, these central banks aren’t trying to buy all of those government bonds. The BoJ buys Japanese government bonds, ETFs, and other assets including foreign securities, while the ECB buys government bonds in the euro area and has just approved buying corporate bonds.
Still, the point remains that there’s a ton of capital chasing bonds and other investments, which will keep interest rates exceptionally low in developed countries.
By extension, these low interest rates on government and even corporate bonds will keep downward pressure on other interest rates. They affect mortgages, car loans, and other consumer finance products.
If things work out this way, the yield curve will flatten. Short-term interest rates will move up when the Fed raises the Fed Funds rate, but longer maturities will move only modestly, if at all. It’s even possible that long-term rates will fall, given a statement Yellen made after the last meeting.
In her press conference, she pointed out that investors were placing too much emphasis on when the Fed would start raising rates for the first time in more than eight years. Instead of focusing so much on when the Fed would start raising rates, she said that investors should pay more attention to the expected time frame over which rates would rise.
That makes me think the Fed might begin pushing up short-term rates sometime this year, but subsequent rate hikes could be few and far between after that.
All of this is good news for anyone who intends to borrow money in the months ahead, and it provides investors with a window of opportunity.
Many interest rate sensitive investments have fallen dramatically over the past six months as investors have worried about higher rates. That means now could be a very good time to go bargain hunting in that sector.
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