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Interest rates will rise when...

edited April 2013 in Fund Discussions
I know a lot of people look at the fed pumping money into the economy and are just sitting back with the popcorn waiting for interest rates to rise and invest with that inevitability in mind. First, there are no easy home runs for average investors. Yet many have been thinking interest rates are about to rise for about 5 years now and they have not. So when will they go up. In my opinion they will go up only under either of the following circumstances 1) People stop saying it is a slam dunk interest rates will rise or people waiting for them to rise die off. 2) There is a change in the party that controls the presidency. So under my scenarios interest rates will not rise for at least another 3 1/2 years because the presidency has no possibility of changing until then and a lot of investors are still are just so darn sure they are going to rise that they just ain't going to rise.


  • I think there's a very different way to understand these monetary issues . . .

    Media love to talk about the Fed pumping money in the economy, but that's terribly misleading. If the private banks aren't lending money actively to businesses and families, then money is not entering the economy. The size of their Fed reserves has no bearing on this.

    The Fed's mission is to promote growth and full employment and to keep inflation moderate. We know that the Fed is keeping the rates low because investment, consumer demand, and export demand are still very low and that this is dampened further by less spending at all levels of government. The Fed has said for several years that it will continue to be forced--as it sees it--to keep interest rates dirt low because the federal government in particular is not stepping up to the plate by boosting spending and getting corporate investment rolling again. That's not about to change any time soon, is it?

    The media also promotes the misconception that the White House controls both government spending and monetary policy. When it comes to interest rates, we know that its the Fed that makes that call. Sure, the president appoints the Fed Chairman when his long term is up, but that person is simply a chairman of a board of the regional reserve banks. (I can't imagine why a Republican president would try to change current monetary policy even if he could--wouldn't it be economic and political suicide to cut government spending even further while also trying to push interest rates up?)

    As you said, Hogan, there's no easy home run for average investors. The Fed has tried to lead all the economic horses to water, but it's up to them to choose when to drink. As long as Federal spending remains frozen while businesses and families restrain their spending, it's hard to see why the Fed would consider raising rates.
  • Reply to @Ginko: I agree the fed is somewhat isolated from the political process but I think you are naive to think the fed does not tilt towards the party in power--they do. I was careful to not say controlled by the party in power. So when we have a new presidency, especially a new party, they are not going to have a more free hand to try and push up interest rates? I think they will, especially if the supporters who put he or she there are tired of earning low rates on their CDs and we still have low growth. They can go to the public and say the low interest rate environment just didnt work otherwise you would have elected the other guy. The possibility certainly goes up in a change in the presidency--don't you agree?
  • Reply to @Hogan:
    Agree with you that the Fed, like the Supreme Court, can be somewhat swayed by political pressure, even if they are effectively autonomous. But like Bernanke himself, the flavor of Fed board members is Republican and more pro-business and pragmatic than it is driven by big/small government partisan issues. Fundamentally, they answer to the banks and not to the politicians. But even it they were somewhat sway-able to the public mood, in the end, it would seem more likely that the interests of businesses and working people would carry more political clout than would the those of retirees dependent on CD's. (Don't we see that in Congress today?)

    While a Republican candidate (Just like a Dem would if the tables were turned.) would undoubtedly speak at an AARP convention and blame low interest rates on the other party and swear to change that, I can't imagine that any (non-extreme) candidate would actually follow through on that and push the Fed to squeeze the economy.

    Without fiscal stimulus, the economy will likely remain depressed and monetary policy will remain unchanged. If the Dems win big in the next couple of years, infrastructure spending may rise significantly, start priming the economic pump, and change that. If it's the Reps, who knows, perhaps there would be a massive increase in non-social Federal spending (e.g., the military) that would have the same effect. In either case, the outcome could result in higher investment and consumer spending, along with inflation creeping up. But then it will be the Fed itself, without any prompting by politicians, that will be pushing rates up.
  • Ginko's analysis is correct. The interest on the short term basis is firmly controlled by the fed. The longer term interest rates are controlled partly by Fed but partly by the market. The fed interest rate policies can change as the composition of the fed changes but that is relatively slow process.

    The fiscal policy also has a role. In the fiscal policy is stimulative (I.e government spending is increasing) the need for monetary stimulus is less and Fed can discontinue its measures. Given the current tendency is to cut the government spending it is very unlikely that we will see a change in Fed policy.

    In case there is a change of party in power, I do not think incoming party will prefer higher interest rates. In a slow economy higher intereset rates is a bad policy as it will reduce the demand for loans and business investment (risk taking)

    Higher interest rates is also known as tight monetary policy and is a tool to slow down a hot economy. If your economy is just barely warm, it is a political suicide to want that.

    The party in opposition often tries to push the party in power to accept such misguided policies because it will slow down the economy and increase their chances of coming back and when they come back they can affect loose fiscal policies to improve their own chance of success from a lower low point. In other words, it is just politics!

    Looking at the example of Europe, they insisted in higher intereset rates when they are in recession and make the already bad situation worse by contributions to rolling crisis. They said that by austerity they will create higher confidence levels. How is that working out! Such fantasy...

    Coming back to when interest rates will go up (unless some political stupidity to do misguided decision) Fed already has told you. If core inflation goes over 2% and stays there or if unemployment goes below 6.5% and stays that way for a while than they will gradually start the process of normalizing the policy. That does not mean they will jack up the interest rates immediately. They will reduce and stop bond buying programs. They can then increase the interest rates. I expect fed will probably will not sell the bonds it had purchass but they will hold them to maturity. They do not need to sell them. The balance sheet will shrink over time and there is really no urgency to shrink immediately. Other tools Fed has in its disposal is Fed window rates and interest paid for excess reserves. They will increase these to tighten the policy as required. These are all very potent tools to fight inflation. In fact they are much more potent against inflation than disinflation and deflation. Deflation is a much harder problem to fight and much more destructive. Fed has been on the correct policy in general in this respect.
  • edited April 2013
    Reply to @Ginko: "without fiscal stimulus, the economy will likely remain depressed and monetary policy will remain unchanged". I agree with your statement, but the counter arguments are not the views of "extreme" candidates? However, I do view in the end the party out of power is much like a spouse in a dysfunctional marriage who does not control the checkbook, complain and complain until you have the checkbook and then you do basically the same thing your spouse was doing when they had control of the checkbook instead of excessive tool and car part purchasing it is yoga outfits and lattes--gender stereotypes aside:) it all gets spent but I just want to spend it on my constituencies.
  • Reply to @Hogan:
    We agree, Hogan, that even if one outcome may be likely, other quite plausible scenarios are always possible. But at the limit, can we rule out that there might even be an "extreme candidate", a real outlier, who might lead a righteous, headlong charge into economic depression for the sake of what he sees as saving the country?

    Although we have been discussing here how exceptional and uncomfortable the Fed's current policies are, it's ironic that it actually seems to be an institution that's actually holding our vital economic core together while Congress flounders.
  • Reply to @Ginko: I think an "extreme candidate" could win an election. I agree with you but a majority of Americans would dispute your characterization of extreme. To a certain extent Congress is playing its role to challenge the president on everything. However, many people elected members to Congess to turn off the spigot of government funding. They view the federal budget much like their family budget don't over complicate this they say to me. You and I know we benefit greatly from being the worlds reserve currency but why couldn't a person who thinks like many members of Congress not get elected president. All I am saying if one does the likelihood of interest rates going up increases.
  • edited April 2013
    Well ... Err... One party does have some fire-brands who'd like to oust Bernanke and ratchet up rates. Than again, if it happened to be Gov. Perry who got in, he'd have trouble remembering who it was he'd intended to fire - so we'd probably be OK. (-: Good analysis Hogan. We humans like to shoot ourselves in the foot - so I think your second option has some credibility.
  • Reply to @Investor: As an add on to my argument when Interest rates will rise, according to current projections it is likely to be 2015. (When inflation exceed 2% or unemployment is reduced below 6.5%)
  • The Fed would LOVE to be in a position to being increasing short-term rates. But with employment wheezing and very little inflation (both of which numbers a lot of people believe are manipulated by the government), and even more importantly, with the velocity of money practically non-existant, there is little chance of higher rates in the near term. It would appear that zero rates are here for a while - at least a year, perhaps longer - unless the three parts of the puzzle above change dramatically. The Fed's mandate is to keep employment at 'full' level (somewhere around 5%) and to keep inflation under control. There is nothing to suggest either item is an issue at this point.
  • edited April 2013
    I'll say low rates until at least 2016 and a slight chance of NIRP at some point.
  • Reply to @BobC: Does that mean longer duration bonds are ok to own now? I think it is but I personally own funds that hold some longer duration but average is more like 4% and not looking for shorter.
  • Reply to @ron: Hi ron. While it may not be totally logical, we are sticking with short to medium-duration bonds for the most part. Except for our muni bond funds, our average durations are very modest. LSBDX has reduced its duration to 4.7. And even our muni funds are fairly tame, too. VOHIX is 6.3, FOHFX is 7.13, and THMIX is 5.73. When I look at something like VUSTX at 15.5, that does scare me. Would not go anywhere near that, especially for only a 2.4% yield! EM bonds don't bother me as much, but even there we are pretty tame. Personally we would rather use dividend stocks than long-term bonds. Prices on many bonds are just too rich for us. Floating rate bonds have some attraction, and their durations are very low with pretty nice yields, too.
  • Reply to @scott:

    If NIRP does happen VUSTX will enjoy another (maybe last) round of capital appreciation. LT treasuries still serves as a flight to safety and responds positively if rates fall further.
  • To Hogan, Glinko, Investor, et al: Thanks for this well-balanced and carefully nuanced exchange. A pleasure to read you folks!

    Regards- OJ
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