Will a federal reserve rate hike be a disaster?

Nobody knows what will happen when the federal reserve finally raises interest rates, not even the federal reserve.

yellen_raise_ratesBack in February I predicted the federal reserve would not raise interest rates in 2015. At each of the last four meetings, the pundits were increasingly certain the federal reserve would raise rates, and Yellen did not. This time, the usual suspects are even more certain. Will they be wrong again?

The federal reserve is generally not a proactive entity, generally leaving rates low until forced to raise them reactively. Many influential economists, right or wrong, warn against any change in economic policy that might derail the economic expansion. The only reasons the federal reserve usually raises interest rates is a decline in currency value, crashing bond prices, or high inflation. Since we have none of those now, only the fear of this happening in the future would prompt a rate increase.

I recently speculated that perhaps banker greed is behind the impetus to raise rates. Lending margins at the major banks are near historic lows. When interest rates fall, at first bank margins widen because they immediately reduce what they pay depositors, but it takes time for competition to force down what they can charge. When interest rates hit zero, they can’t pay depositors any less (at least not yet), so competition finally squeezes their margins until they hardly make any money at all.

I also noted that some economic models theorize that a small increase in interest rates could stimulate the economy.

When bank deposits earn nothing, the billions of dollars of risk-adverse savers like senior citizens earn nothing. When interest rates go up, the burden on borrowers increases, reducing their economic activity; however, the income to savers and bank depositors increases by equal measure, and many will spend it, particularly the seniors who need this money to make ends meet.

Thus, raising interest rates has the potential to stimulate consumer spending by putting money in the hands of bank depositors, many of who will withdraw with interest income and spend it.

interest rates and demand

Nobody really knows what will happen with interest rates across the yield curve when short-term rates go up. Perhaps the strengthening currency will attract more foreign investment elevating bond prices keeping long-term interest rates low. Perhaps raising the short-term rates will force long-term rates higher as investors abandon long-term debt in favor of short-term debt that now provides some yield.

The only way to find out is to raise rates and see what happens.

Lazerson: Fed rate hike will backfire

By JEFF LAZERSON, Nov. 20, 2015Janet-Yellen-in-Banker-Instinct-2

The Fed rate increase is an overrated turkey.

Whether you have an adjustable-rate mortgage or a home equity line-of-credit, do not fret about mortgage rates going up when the Federal Reserve raises short-term interest rates one-quarter point on Dec. 16. This will be short-lived.

Actually, borrowers who struggle on the margins have a great deal to worry about because their cost of debt service will go up. The question is will it stay up.

No doubt things are a million percent better than they were during the height of the Great Recession, especially here in Orange County. But we’re still ailing on many levels. The rate increase is medicine we are not ready for.

Debt addicted Orange County will never be ready for a rate hike.

Consider the employment participation rate, which is the number of people who are either employed or actively looking for work. According to the U.S. Bureau of Labor Statistics, the October participation rate of 62.4 percent is the lowest level in nearly four decades.

There is an ongoing debate in macroeconomic circles as to whether this statistic is still meaningful. Some of the decline is due to demographics, as I noted in the housing market headwind nobody saw coming.


Nobody knows how many of these people are coming back.

Consider the promising, yet meager wage gains that the American worker has enjoyed, only to be eaten up by, at minimum, higher health care premiums and utility charges. Think there’s a panacea of real disposable income out there that’s going to drive up inflation? Think again.

Consider The Wall Street Journal’s recent headline, “Quiet U.S. Ports Spark Slowdown Fears,” which explained a recent 10 percent drop in imports being shipped. That’s the first time in 10 years. And, it comes at high shipping season. And, it’s very consistent with other recent news accounts of rising inventories at retailers.

I recently described how the declining export employment weakens housing demand. The rising dollar is hurting exporters, and if the federal raises rates, it’s likely the dollar will get even stronger exacerbating a problem with dwindling export employment.Janet-Yellen-Bubble

“The Fed’s narrative is at odds with reality. Demand is the issue. There is no demand,” said Christopher Whalen, senior managing director at New York-based Kroll Bond Rating Agency.

Political expediency will win the day on the matter of a rate increase, only to see a consumer spending pullback by the first quarter of 2016.

This drives to the heart of the economic debate. We really don’t know if a small raise in short-term rates will have this effect. If it puts more money into the hands of bank depositors, and if they withdraw this money and spend it, consumer spending may actually rise.

Lenders are getting lit up with calls ahead of the December Federal Open Market Committee meeting. If you are one of the many mortgagors who have your loan officer on speed dial because of RO (rate obsession), erase that anxiety from your mind and quit calling.

Mortgage rates are going to fall right back down as a result of this premature Fed move because that same political expediency is going to work for you after the economic slowdown.

That’s a bold call on rates.

He might be right for the reasons he described. He could be right for the wrong reasons as well. Long-term rates might fall because to higher short-term rates prompts a rally in the dollar and a flood of foreign investment, driving down long-term rates.buh bye janet

He could also be totally wrong if raising the short-term rate forces long rates higher.

We’re coming up on a big election cycle in less than one year. No matter your political party, all incumbents want you feeling good about them as part of their effort to get re-elected. That’s no turkey talk. That’s political reality.

We’ve discussed this in the astute observations. The federal reserve has a brief window to tinker with interest rates in the first two quarters. If they haven’t established a pattern and provided plenty of unambiguous guidance, they may be accused of swaying the election with a rate hike near the election.

Whatever the federal reserve decides to do, there is nothing positive about rising mortgage rates for the housing market. Many analysts believe the market can handle higher mortgage rates, but I don’t agree. Rising interest rates do not boost house prices, nor do they help sales volume.


So what do you think will happen? Will the federal reserve raise rates in December? Will it positively impact the economy?

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