The era of 0 percent interest rates in the U.S. is finally coming to an end. You can even mark it on your calendar.
On December 16, the Federal Open Market Committee will almost certainly announce a 25 basis point increase in baseline interest rates. This will be the beginning of what the Federal Reserve has said will be a relatively slow and gentle trend back toward something resembling normalcy. Although future events could change regulators’ plans, the most likely scenario is that the Fed will announce two or three similar increases during 2016, which would get the baseline interest rate to around 1 percent by the end of the year.
Of course, that would still mean nominal rates are very low, even at this time next year. And while stock markets continue to show a lot of anxiety over a potential increase, the real question is probably how the bond markets will react. A lot of private economists and analysts have warned that corporate bond markets, in particular, are less liquid now than a few years ago, because regulators have discouraged financial institutions from maintaining inventories. Economists working for the Fed have questioned this conclusion, though I am inclined to call that skepticism the luxury of being the regulator.
An increase to 1 percent does not sound like much, granted. But consider: Germany recently issued a two-year government bond at a record low yield of negative 0.38 percent. In other words, investors are paying the government to hold their money and eventually give most of it back. The average yield on German government debt first reached negative territory back in April. Two-year bond yields are also currently negative in France, the Netherlands, Austria, Finland, Belgium and Ireland, The Wall Street Journal recently reported.
From an economist’s point of view, this development is a sign that policymakers in Europe are deeply concerned about deflation. From my vantage point as a businessman, it is a signal of something like despair: People in Germany and other European nations literally cannot find a more productive place to put their money at acceptable levels of risk.
But, as has been the case in the United States since the financial crisis, central bankers have engineered historically low interest rates to prop up the economy while demand is scant and labor is not impressing anyone with its productivity. We are now in the seventh year of a tepid recovery, whose hallmarks have been the unusual situation of shrinking labor force participation - even as unemployment has dropped sharply - along with scant credit growth and largely stagnant wages, despite the tighter job market.
These factors have arrived amid the many drags that have burdened the marketplace, from regulators’ micromanagement of banks to the uncertainty surrounding the costs and mandates imposed on businesses by the Affordable Care Act. The Fed has tried to overcome these drags with high-octane monetary stimulus, but its fuel tank is basically dry at this point. The Fed needs to give itself some room to respond to further economic shocks, too.
So there really will not be a better time for the FOMC to act than next month. In September, regulators delayed largely due to international activity. As of late October, however, the Fed was ready to downplay global market turmoil and emphasize the U.S. labor market’s continuing, if slow, recovery. In Congressional testimony on November 4, Fed Chairwoman Janet Yellen said, “December would be a live possibility” for an interest rate increase, but hedged by saying no final decision had been made. And a variety of other Fed officials have made guarded comments in the past few weeks indicating December was certainly at least under strong consideration. It seems the Fed has spent much of the past month or so laying groundwork for its long-delayed decision to let interest rates creep back upward.
The fact is that even if the ideal moment has already passed, acting now is almost certainly preferable to acting later. Pushing off the rate increase into 2016 risks unintended consequences in next year’s presidential election, and would also mean a future economic shock could unexpectedly close the Fed’s window of opportunity.
At long last, look for a tiny, tentative step back toward normalcy.
Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book,
The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book
Looking Ahead: Life, Family, Wealth and Business After 55.
Posted by Larry M. Elkin, CPA, CFP®
The era of 0 percent interest rates in the U.S. is finally coming to an end. You can even mark it on your calendar.
On December 16, the Federal Open Market Committee will almost certainly announce a 25 basis point increase in baseline interest rates. This will be the beginning of what the Federal Reserve has said will be a relatively slow and gentle trend back toward something resembling normalcy. Although future events could change regulators’ plans, the most likely scenario is that the Fed will announce two or three similar increases during 2016, which would get the baseline interest rate to around 1 percent by the end of the year.
Of course, that would still mean nominal rates are very low, even at this time next year. And while stock markets continue to show a lot of anxiety over a potential increase, the real question is probably how the bond markets will react. A lot of private economists and analysts have warned that corporate bond markets, in particular, are less liquid now than a few years ago, because regulators have discouraged financial institutions from maintaining inventories. Economists working for the Fed have questioned this conclusion, though I am inclined to call that skepticism the luxury of being the regulator.
An increase to 1 percent does not sound like much, granted. But consider: Germany recently issued a two-year government bond at a record low yield of negative 0.38 percent. In other words, investors are paying the government to hold their money and eventually give most of it back. The average yield on German government debt first reached negative territory back in April. Two-year bond yields are also currently negative in France, the Netherlands, Austria, Finland, Belgium and Ireland, The Wall Street Journal recently reported.
From an economist’s point of view, this development is a sign that policymakers in Europe are deeply concerned about deflation. From my vantage point as a businessman, it is a signal of something like despair: People in Germany and other European nations literally cannot find a more productive place to put their money at acceptable levels of risk.
But, as has been the case in the United States since the financial crisis, central bankers have engineered historically low interest rates to prop up the economy while demand is scant and labor is not impressing anyone with its productivity. We are now in the seventh year of a tepid recovery, whose hallmarks have been the unusual situation of shrinking labor force participation - even as unemployment has dropped sharply - along with scant credit growth and largely stagnant wages, despite the tighter job market.
These factors have arrived amid the many drags that have burdened the marketplace, from regulators’ micromanagement of banks to the uncertainty surrounding the costs and mandates imposed on businesses by the Affordable Care Act. The Fed has tried to overcome these drags with high-octane monetary stimulus, but its fuel tank is basically dry at this point. The Fed needs to give itself some room to respond to further economic shocks, too.
So there really will not be a better time for the FOMC to act than next month. In September, regulators delayed largely due to international activity. As of late October, however, the Fed was ready to downplay global market turmoil and emphasize the U.S. labor market’s continuing, if slow, recovery. In Congressional testimony on November 4, Fed Chairwoman Janet Yellen said, “December would be a live possibility” for an interest rate increase, but hedged by saying no final decision had been made. And a variety of other Fed officials have made guarded comments in the past few weeks indicating December was certainly at least under strong consideration. It seems the Fed has spent much of the past month or so laying groundwork for its long-delayed decision to let interest rates creep back upward.
The fact is that even if the ideal moment has already passed, acting now is almost certainly preferable to acting later. Pushing off the rate increase into 2016 risks unintended consequences in next year’s presidential election, and would also mean a future economic shock could unexpectedly close the Fed’s window of opportunity.
At long last, look for a tiny, tentative step back toward normalcy.
Related posts:
The views expressed in this post are solely those of the author. We welcome additional perspectives in our comments section as long as they are on topic, civil in tone and signed with the writer's full name. All comments will be reviewed by our moderator prior to publication.