The Fed Wants/Needs Interest Rates Higher, But Too Risky In Here
The US Fed policymakers are meeting Tuesday and Wednesday. And Fed watchers are looking for clues about when the FOMC will raise short term interest rates.
But, globalization now makes that decision less important for the economy and stock prices than in the past according to some economists.
The Fed has good reason to want higher rates.
Zero + interest rates make longer term bank lending to businesses less profitable and risky, because when interest rates rise again, banks take losses on longer term loans still on their books.
Instead, of lending to business at the very low rates, banks are encourage banks to finance trading in commodities and securities and private equity deals, those turn assets and repay loans quickly adding very little economic growth but booking healthy profits for the big banks that have access to the Fed window.
Should the Fed raise rates the US economy and global markets will suffer.
You have heard a lot about the improving jobs market and retail sales, but the May rise in employment is likely a temporary bounce from the extreme Winter.
Stronger May retail sales were driven by new car purchases and rising gasoline prices. Larger monthly payments to service auto loans and the continuing surge in fuel prices will constrain future increases in consumer spending, count on it.
The US economy is seeing slow to no growth, and cannot not stand higher medium and longer term interest rates, especially in the Key auto and housing sectors.
And in this world economy, globalization keeps the Fed from raising its rates.
The Fed’s principle policy tool is its ability to vset the banks’ overnight borrowing rate, aka the fed funds rate.
But, the effectiveness of Fed policy depends on whether increasing that rate significantly pushes up rates on mortgages, corporate and municipal bond and other longer term borrowing. In turn, whether higher bond rates push investors from stocks into bonds, heading off any emerging bubble in stock markets.
The longer rates peg off the rate on 10-yr US Treasury securities but from June 2004 to June 2006, when Ben Bernanke increased the federal funds rate from 1 to 5.25%, the 10-yr Treasury rate rose just 0.6 percentage points to 5.22%.
Mr. Bernanke’s efforts to raise long rates and curb bubbles in real estate and equity markets were dampened by global investors.
Unlike the days of Paul Volcker, Alan Greenspan and earlier Fed Chairmen, Euro, not the Buck finances much of the international trade and investment transactions among European nations. Now Yen and RMB Yuan have displaced the USD as the currency of choice in Asia.
The USD is actually a US Treasury securities, and has become just another investment asset, like bonds issued by the German and Japanese governments.
Now, the European and Asian central banks are all pursuing aggressive low interest rate policies, these are aimed at cheapening their currencies against the Buck and boosting exports to the United States.
As 10-yr US Treasury rate attempts to rise with an increase in the federal funds rate, investors will exit lower-paying Asian and European government bonds into US Treasuries.
Fed policymakers will learn that just as General Motors (NYSE:GM) cannot raise prices without considering pricing at Toyota (NYSE:TM), the Fed cannot push up the price of money where it counts, at the 10-yr T-Note rate, without paying close attention to what foreign central banks are doing.
So, the Fed will be frustrated in its efforts to significantly push up 10-yr T-Note, mortgage and corporate bond rates, moderate the pace of home buying and corporate borrowing to buy back shares to boost stock prices.
Savvy and crafty, non-bank firms that finance much of the new car buying will use longer term bonds to keep auto loan rates from rising much.
This being the case, the Fed is becoming less relevant in the global make up of thing, because the US economy and the Buck no longer dominate the global economy.
Shayne and I do not expect to see the Fed raise rates until well into Y 2016, if ever.
Stay tuned…
HeffX-LTN
Paul Ebeling
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