After years without a rate hike, the Federal Reserve is really diving into the hikes now as they increased the federal funds rate by 0.25 percent for the third time in six months. The move wasn’t exactly a surprise for anyone, as the Fed has spoken about how they believe the economy is ready for a rate hike. But now it looks like they’re really buying into that theory, and why that might be needed right now
What’s Happening to the Federal Reserve?
The federal funds rate has seen more action in the last six months than the last few years combined. And that’s a good thing. That means that rather than just saying they believe in the economy, the Federal Reserve is proving it by saying that Americans can handle their interest being more expensive. And while that can be a little annoying for consumers, it’s actually a good thing. The federal funds rate is a short-term interest rate applied to financial institutions which loan funds to other financial institutions (usually overnight). This rate affects monetary and financial institutions, which in turn affects employment, growth, and inflation. Basically, the higher the federal fund rate, the more expensive it is to borrow money. The more a bank pays for its money, the more the bank’s customers have to pay for mortgages, car notes, credit cards, and loans.
This increase pushes the federal funds rate over 1% for the first time since 2008 during the last U.S. recession. And while that may seem high, the rate needs to continue going up. The average rate over the years has been about five percent, so we’ve got a long way to go. That’s important because since World War II, the country has experienced recessions about once every six years. Which means another recession is coming. It’s not a question of if, but when. Interest rates are used to combat recessions by lowering rates to facilitate not only spending, but more favorable conditions for borrowing.
Find out more about Fed’s third rate hike by watching this news clip from CBS News:
That’s why more rate hikes are on the horizon, and why you should be okay with those hikes. The Fed believes economic growth has rebounded, and this latest rate hike is the proof.
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Fed President: Low Rates Will Make Next Downturn Even Worse
In a surprising bit of honesty, a Federal Reserve Bank President admitted yesterday that by keeping interest rates low for so long, they’ve made the next economic downturn even worse than it would have otherwise been.
Boston Federal Reserve President Eric Rosengren said that years of low interest rates led to excessive risk-taking in commercial real estate. With this, now, the pandemic will create a surge in defaults and bankruptcies. This may take place as businesses across the country fail and workers lose their jobs.
He said the economy would have suffered from the pandemic no matter where the Fed had interest rates were at the time. However, the excessive risk-taking due to low interest rates means the recovery will be even harder.
“Clearly a deadly pandemic was bound to badly impact the economy,” Rosengren said. “However, I am sorry to say that the slow build-up of risk in the low-interest-rate environment that preceded the current recession likely will make the economic recovery from the pandemic more difficult.”
With interest rates so low, Rosengren says commercial real estate firms happily took on more risk in order to maximize their returns.
They “gradually increased risk by taking on more leverage,” he said. This”magnifies returns with good outcomes – but also magnifies losses when bad outcomes occur.”
“This increase in risk-taking is more likely to take place in a low-interest environment,” he added. Rosengren likened it to “the one which prevailed in the aftermath of (and as a result of) the financial crisis and Great Recession.”
The “low rates persisting for an extended period even after the economy has made progress in the recovery” said Rosengren. Here, he specifically addressed the Fed’s decision to keep rates at near-zero for more than six years. The Fed did so while the country recovered from the Great Recession.
During periods of low interest rates, “businesses and firms take on additional debt and accumulate more risky assets in search of better returns,” he said. This potentially bids up “asset prices to unsustainable levels.”
Now, occupancy rates are plunging amidst the pandemic. Tenants are also looking to pay reduced rent or skip paying altogether. With these, commercial landlords are getting pinched.
A Spike in Unemployment
Rosengren also expressed concern about the resulting spike in job losses as many of the businesses close.
“The build-up in risks in commercial real estate, and leverage in the corporate sector, prior to the COVID-19 pandemic are likely to result in more bankruptcies and higher unemployment during this crisis than if less risk had been taken,” he said.
The situation will likely only worsen unless another round of stimulus is passed that includes more funding for PPP loans. It is a vital way for small businesses to continue paying rent. If there are no more PPP loans, more businesses will likely go under, putting commercial real estate into further peril.
Fed Chair Powell: ‘A Long Way To Go’ Until Economy Is Out Of The Woods
Federal Reserve Chairman Jerome Powell said yesterday that the economic recovery still has “a long way to go” despite significant progress in job creation, goods consumption, and new business formations. He also said now is not the time to pull back on both fiscal and monetary stimulus.
“While the combined effects of fiscal and monetary policy have aided the solid recovery of the labor market so far, there is still a long way to go,” Powell said.
If policymakers take their foot off the gas, it could “lead to a weak recovery, creating unnecessary hardship for households and businesses,” Powell said. He also mentioned that it could slow an economic rebound that has progressed more quickly than expected.
“By contrast, the risks of overdoing it seem, for now, to be smaller,” Powell said while talking with the National Association for Business Economics. “Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.”
Powell on Fiscal Measures
Powell praised lawmakers for their quick response with fiscal measures in March and April. He said they were “by far the largest and most innovative fiscal response to an economic crisis since the Great Depression.”
He cautioned that pulling back on both fiscal and monetary stimulus could increase the risk of an economic slowdown. This slowing down would become completely different from the one caused by the coronavirus this spring. It’s also one would be much harder to recover from.
Additionally, he said that when “weakness feeds on weakness” signals the creation of this type of slowdown. This creation can occur when the economy slips into recession. It also kicks off a cycle where layoffs lead to lower consumer demand and thus more layoffs.
He added that targeted help should be provided for businesses hit hardest by the pandemic. He also mentioned that the “right thing to do and the smart thing to do” is to continue financial support for workers whose jobs may never return.
Powell mentioned the disproportionate impact the economic downturn had on those at the lower end of the socioeconomic ladder. He said employment rates for the lowest rung of the wage distribution scale is still 21% below its February level. Meanwhile, workers who receive higher wages have only seen a 4% dip in the employment rate.
“A long period of unnecessarily slow progress could continue to exacerbate existing disparities in our economy. That would be tragic, especially in light of our country’s progress on these issues in the years leading up to the pandemic,” Powell said.
Two interesting notes from Powell’s talk:
During a question and answer session, Powell said now is “not the time” to worry about getting the federal budget deficit back on a sustainable path.
Someone also asked Powell if he felt worried about a spike in inflation. To this, he said disinflationary pressures persist all around the world.
“We are still seeing downward pressure on inflation and I think it’s appropriate for central banks and certainly the Fed to take that into account,” he said.
Fed President: Low Interest Rates Push Investors To Take On More Risk
If you are looking to buy a house, refinance your current mortgage, or make any big ticket purchases, it looks like you’ve got quite some time to borrow money at historically low interest rates.
That’s according to Dallas Federal Reserve President Robert Kaplan. During a CNBC interview, he said the central bank will keep interest rates at near-zero for at least the next three years. This comes as the US economy continues to climb out of the hole created by the coronavirus pandemic.
“I think we’re going to need to keep the Fed funds rate at zero … for the next probably 2½ to three years years,” Kaplan said in the interview. “It could be that long until we get on track, to have weathered the crisis and are on track to meet our full employment and price stability goals.”
Reason for Kaplan’s Vote
During the last FOMC meeting, Kaplan was one of two committee members to vote against the policy action. However, he said during his interview that he made that vote because he wants the central bank to have flexibility. He said he did not want it to commit to a specific timeframe.
“My dissent is about making commitments beyond that point. I think beyond that point, I’d rather see us keep some flexibility,” Kaplan said.
He added that they may keep interest rates low beyond the point that they would have raised them in the past. This may happen with the new inflation targets set out by the Fed.
“I don’t know if that’s going to be appropriate. Historically, it wouldn’t have been. With the new framework and our inflation targets, I think we’re going to be more accommodative than we have been in the past, but I don’t know if we want to be committing to keeping rates at zero until we meet these targets.”
On Low Interest Rates
He also explained his concern with low interest rates for such a long period of time. Kaplan said investors starved for interest income are forced further out on the risk curve to meet their needs.
“I’m generally worried that if we keep rates at zero longer than we have to, that it forces people out onto the risk curve and they’ve got to take on more risk, you can’t have money in savings, you can’t have money in bonds by and large, especially in shorter bonds. And I think we saw a little bit of this in March, in that some of the selloff in March was COVID related and lockdown related, but part of it was forced selling in risk markets because people had too much risk on. And that’s what happens and that’s the danger if you go for a prolonged period of time and you get excess risk taking, when the markets do go down, it can be more severe and destabilizing.”
Coping With a Crisis
He said we need what the Fed currently does with interest rates and asset-buying because of the crisis. However, the Fed can only do so much and things could turn for the worse without more stimulus.
“Obviously, we’re doing extraordinary actions, not just the Fed funds rate but also what we’re doing with the 13(3) programs and asset-buying, but we need to because it’s a crisis,” Kaplan said. Here he was referring to the emergency lending enabled under the 13(3) powers of the Federal Reserve Act.
“One of the unusual things about this pandemic has been consumer income and consumer spending has stayed resilient, and a big reason why is fiscal support,” Kaplan said. “I think it would create downside risk if we weren’t going to get that fiscal support.”
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