I find the entire debate surrounding economic interest rates to be highly significant at the moment. What is supposed to be a policy tool used by the Federal Reserve to contain inflation and occasionally encourage either economic expansion or contraction has turned into a drug which our economy is gradually becoming immune to. The debate over interest rates is currently taking place at high level institutions such as the Federal Reserve who understand that if they wait too long, the drug can have serious consequences. The debate is also taking place across America where portfolio values and real estate prices have been on the rise, giving people the satisfaction of passively achieved wealth. That satisfaction, however, is partially masked by the concern of bubbles and whether those asset prices may come back down at some point soon.
There are many factors which help to explain why interest rates began their gradual decline from the 1980’s through the 2000’s. What I’m most concerned about is the past 5-10 years in which rates have bottomed out and remained that way until now. It’s this period which begs the question of whether our economy is immune at this point or if this policy move is finally generating some of its desired outcomes including a lower unemployment rate and sustained economic growth. The reality is that it’s probably a mix of both: the low-rate policy is finally starting to work but it took much longer than expected and is creating concern about both inflation and asset bubbling in the stock, bond, and real estate sectors.
So what should we do? From my perspective, we need to gradually begin the process of raising rates. Low interest rates are training wheels which our growing economy can finally start to live without. If we start raising them now, they will still exist as a policy tool when we have a future recession or other issue which requires rate reduction. Further, we have to proactively combat inflation which is an active risk that gets repeatedly dismissed by the Federal Reserve. Official statistics repeatedly indicate that inflation is nowhere to be found but I find that very hard to believe. Everything from a bottle of water to a train ticket to an education has gone up in price dramatically over the past 5-10 years. It may not be hyper-inflation, but it’s regular, incremental inflation. I think a policy of gradual rate increases would be appropriate right now and curb the risks of both inflation and making this policy tool obsolete.
Now, what will actually happen? In all likelihood, the Fed won’t do anything for the next 6-12 months. Janet Yellen is the Fed boss and she says that economic growth is slow and that our economy is very fragile. She wants to see more incoming economic data before taking the risk of raising rates. Further, she doesn’t think inflation is a major concern because wage increases apparently haven’t gone up consistently enough to spur on inflation. The Fed also believes they can correct the asset bubble concern through regulation and preventative measures against speculation. I hope they’re right, because that risk appears to be spreading as well, including new areas like student loans which deserve more attention than they are currently receiving.
Some may say it’s ironic that I feel this way because, as a money manager, low rates are my friend. Portfolio values are higher than ever which makes me look good, even though its more Janet Yellen and Ben Bernanke who deserves biggest thank you. If Yellen wins this Fed debate to not raise rates until mid-2015, we’ll quite possibly see further increases in stock prices, more bubbling of bond prices and a solid 2015 for major real estate markets. Even so, I’m looking out 10 years. I’d rather see slow, gradual growth in asset prices over rapid growth which then declines, creating uncertainty and further volatility. Plus, I’d like to see this policy tool stick around for a while because I think we’ll need it again sooner than later.
As always, feel free to contact me with any questions or comments.
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