Interest Rates: Lower for Longer
The path of interest rates is closely followed by investors, economists, and consumers; and for good reason. The actions of the Federal Reserve and their impact on interest rates help determine “the cost of money,” which, in turn, influences lending rates, economic activity, and capital markets.
As many may recall, coming out of the recession of 2008-09, the Federal Reserve reduced the Federal Funds Rate to zero with the goal of stimulating the economy and business activity. The Federal Reserve waited nearly seven years to move rates up from zero; beginning to incrementally increase rates in the fourth quarter of 2015 and continuing through the fourth quarter of 2018. In that time, equity markets performed well, the U.S. elected a new president, and inflation remained in check. It is unlikely that the Federal Reserve would have hiked rates had they not felt the U.S. economy was on good footing, as premature or inappropriate rate hikes can have painful consequences for an economy that is not truly healthy.
With a few years of slow and steady hikes, many investors are wondering what will happen next. There is increasing support for the idea that rates will remain low for a long time and may possibly drop even lower than where they are now. The Chair of the Federal Reserve, Jerome Powell, stated in the first quarter of 2019 that they will “be patient with [their] policy and allow things to take time to clarify (Reuters)”. Aside from Powell’s statement, there are other reasons to believe that rates may remain low, including fears of slowing growth in the U.S. economy, corporate profits, and global markets, as well as persistently low inflation.
As market observers have witnessed, the President is not hesitant to make public suggestions as to how the Federal Reserve should treat interest rates. The market sell off of late 2018 was fueled in part by concerns that global economic growth was slowing and the Federal Reserve had gone too far with rate hikes. Equity markets reacted poorly, President Trump made it abundantly clear that he wanted lower interest rates, and the market watched a power struggle unfold between Trump and Powell. Aside from the public demands of the President, there are underlying concerns that economic growth is slowing in the U.S. and that the economy is running out of catalysts for growth. The first quarter of 2019 saw a strong annualized growth rate of 3.2%, but skeptics point to increased inventories and a reduction in the trade deficit as key drivers of this. And while corporate tax breaks gave a boost to business activity and stock prices, should economic activity stagnate or slow again, lowering interest rates may be the remaining option.
The effects of the ongoing trade dispute with China have also been felt by certain pockets of the economy and equity markets. Should trade talks with China go awry, the Federal Reserve may not want to fan the flames with higher rates. The current economic expansion has been in running for a long time. However, the fact that the expansion is “old” is not a reason to believe that it will abruptly end. There would need to be a cause, such as protectionist trade practices or slowing growth outside the U.S. Either of these could potentially point to lower rates or no hikes for the time being.
Outside of the U.S., there is also cause for concern around slowing growth. Just as it impacts the United States, the U.S.-China trade dispute has had an adverse effect on the Chinese economy. Other global concerns include volatile oil and energy prices, political unrest (such as in Venezuela and the Middle East), and internal political issues in Europe, including high spending rates (Reuters). The influence that Central Banks have in Europe and elsewhere has also come into question, as has the issue of entitlements and unemployment in areas of Europe. The European Central Bank has already deployed stimulus measures in the last decade, however, economic problems continue to persist. These growth concerns pose potential problems for the U.S., which is another reason for the Federal Reserve to be cautious with interest rates.
The stated goal of the Federal Reserve is to maximize employment and keep inflation in check (which typically means around 2%). Currently, the U.S. economy is close to this. The Federal Reserve’s goal, in theory, is not to influence stock prices. This notion has been called into question by market observers, as the market is reactive to Federal Reserve’s statements and actions, at least in the short term. Given the potential market volatility of the concerns addressed above, and the market sell-off in late 2018, it is difficult to ignore the timing of the Federal Reserve’s more cautious stance on rates. One could make the case that the Federal Reserve has its eye on equity values, and thus, it is unlikely that rates will move upwards in the near future.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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