The Federal Reserve is meeting today and tomorrow, and tomorrow afternoon they will announce if they are going to change the Fed funds rate from its current range of 0 to 25 basis points. As the graphs below (from http://www.clevelandfed.org/research/data/fedfunds/index.cfm) show, not only is there almost no chance of them raising rates at this meeting, but even out to April it looks very unlikely that they will do so.
In my opinion, the market has this right; the Fed should keep interest rates unchanged for a long time to come. By law the Fed has a dual mandate — it is supposed to keep inflation low and keep us as close to full employment as possible.
Right now, inflation is not a major problem, particularly outside of energy prices. The biggest single component of the Consumer Price Index (CPI) is Rent, both in the form of Owners Equivalent Rent (OER) which is what a homeowner “pays” themselves to rent the house they own, and regular rent which is what tenants pay landlords. Together, they comprise over 30% of the CPI, and a greater proportion if you strip out food and energy. With vacancy rates at record highs, rents will be under pressure for a long time to come.
Unemployment & Fed Tightening
Unemployment, on the other hand, is a very big problem at 10.0% (U-3) and underemployment at 17.3% (U-6). Historically, the Fed has not started to tighten until well after the unemployment rate has peaked. After the 1991 recession it waited 18 months after the unemployment rate peaked to start to tighten up, and after the 2001 recession it waited a full year after the employment peak.
While the rate did hit 10.1% in October (originally reported as 10.2%) it is far from certain that it was the high point for the cycle. Both of the previous two recessions were very mild relative to this one, meaning that the Fed should be more cautious about tightening this time than they were last time. On the other hand, a good case can be made that the Fed contributed to the housing bubble by keeping rates too low for too long after the 2001 recession.
Normally the unemployment rate rises for many months after the economy starts to add jobs on balance. That is because discouraged workers, who right now are counted as neither employed nor unemployed will rush back into the labor market — and their first stop will be on the unemployed side. While the economy did add 4,000 jobs in November, we lost 85,000 in December. So it does not look like we have even achieved the net job addition stage.
Thus, it the Fed follows recent precedent, the earliest one could expect them to raise rates would be in October, and that assumes that October 2009 was the worst point for unemployment in this cycle. I don’t think I am being unduly pessimistic in thinking that is unlikely.
Who Low Rates Have Helped Most, Least
The ultra low-rate policy by the Fed has played a large role in the apparent return to health of the major banks like Wells Fargo (WFC) and Bank of America (BAC). They are allowed to borrow for free and lend it out at much higher rates (up to a credit card rate in the low 30%s, though that is a small minority of the loans they make). Still, even if they invest it in 5-year T-notes they are making a very profitable spread. Low interest rates have also made it possible for homeowners to refinance their mortgages (provided they are not underwater), and has helped defuse the exploding adjustable rate mortgage bomb.
The downside of the low-rate policy is that savers are hurt since they are getting almost no return on their savings. The elderly in particular are likely to have a large portion of their savings in CDs or other low-yielding vehicles like money-market accounts. Many of them depend on that interest income for basic living expenses, but that income has been almost entirely eliminated. If rates are held too low for too long, inflation could become a more serious issue in the future, even if it is not one now.
That being said, the biggest issue right now for the Fed is unemployment, and any rate hike would only serve to make the problem worse. Indeed, the Fed has gone beyond just a zero interest rate policy and has bought other long-dated assets, which effectively eases monetary policy even more than a zero rate policy would.
Those programs, most notably the purchase of $1.25 Trillion in mortgage-backed securities, are almost complete. Because of this, there is already going to be some net tightening of monetary policy, even without a rate increase. The Fed statement will be closely examined for any indications that such policies might be extended (they probably won’t be).
Ben Nearing the End?
It is also possible that this could be the last Fed meeting with Ben Bernanke at the helm, although the odds for his reconfirmation have improved over the last few days. If the Senate is unable to overcome a filibuster over his reconfirmation, the uncertainty about the future course of monetary policy would probably hit the markets very hard.
In my opinion, Bernanke deserves very high marks for his actions since the crisis hit, but very low marks for the period beforehand. He was slow to recognize the storm that was brewing, and was in a position to have defused the situation, or at least greatly reduced its severity. However, after the crisis hit, he acted promptly and forcefully. Without the actions he took, it is very likely we would now be in the second Great Depression, rather than just emerging slowly from the Great Recession. Thus I would on balance vote to reconfirm him if I were in the Senate.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.
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