WHEN WILL INTEREST RATES RISE?
Here’s a trivia question for you: when was the last time the Federal Reserve raised the benchmark U.S. interest rate?
The answer: June 29, 2006. On that day, the federal funds rate hit 5.25%. It has declined ever since, and it has stayed at 0%-0.25% since December 16, 2008. The Fed expects to hold interest rates at 0%-0.25% through late 2014, and some analysts think they will remain there into 2015.
All that noted … when should the Fed make a move with rates, and what might happen when rates approach something like historical norms?
Right now, the Fed has little incentive to make any moves. Our economy generated only 75,000 new jobs per month in the second quarter of 2012 compared to 226,000 a month in the first quarter. Unemployment is currently at 8.2% and we have housing and business sectors that are far from healed. Hiking the federal funds rate in such an environment would seem nonsensical. In fact, the Fed’s rationale for its current policy is that interest rates need to stay at or near these levels until we reach full employment (a 5-6% jobless rate). Low interest rates help to encourage business investment and big-ticket purchases, though they are no boon to retirees.
Does the economy warrant further easing? Maybe not. The federal government’s second estimate of Q2 GDP (+1.5%) exceeded the +1.2% consensus forecast of economists polled by Briefing.com. That might signal the Fed to hold off on QE3.
When might rates rise? It might be a while. Right now, we have very mild inflation: as of June, the Consumer Price Index was up just 1.7% across the past 12 months, within the Fed’s target. Demand for capital isn’t what it was before the recession, encouraging lenders to stay competitive. The Fed, the Bank of Japan and the European Central Bank have all printed more money, which encourages low interest rates in the short term.
Of course, bloating the money supply might stimulate inflation in the long run. Some see greater inflation on the horizon: a June Pimco analysis forecast inflation rates rising during the next 3-5 years, citing shifts in exchange rates and rising commodity prices as potential drivers. Earlier this year, Slate founder and Bloomberg View columnist Michael Kinsley warned of “a fierce storm of inflation sometime in the next few years” that will “wipe out a big chunk of the national debt, along with the debts of individual citizens, and the savings of others.”