“If everyone is thinking alike, then somebody isn’t thinking.” General George S. Patton
Question: What are your thoughts on interest rates?
Answer: When it comes to making predictions, I’ve learned over the years that it is helpful to plan for occasional economic wildcards and look for trends rather than absolutes. Current events such as dramatically lower oil prices, international tensions, a stronger than expected U.S. dollar and dramatically lower oil prices all influence interest rates and make it difficult to predict the timing of any movements. While expectations might be for rates to move higher, and they will, let’s focus on what could truly cause them to rise.
The Fed’s primary purpose is to provide a stable monetary and financial system promoting maximum employment and stable prices. Regulating interest rates is one of the tools The Fed and other Central Banks internationally use to accomplish this goal. Raising rates decelerates economic activity while lowering rates generally stimulates growth. Federal Reserve Chairwoman Janet Yellen is very “data-dependent” and encourages markets to focus on real incoming data rather than Fed meeting minutes, speeches or statements.
Don’t get it wrong
If the Fed raises rates too soon, the economy could slow too much or even fall into disinflation. If that happens, there aren’t too many ways to pull out a downward spiral and fix the mistake. If the Fed waits too long to increase rates and inflation does pick up, it’s far easier to raise rates rapidly to slow down overheated economic activity. Patience and time are essential elements to the equation.
As a reference point, the U.S. Government is currently paying 2.00% to borrow money for ten years in the form of a U.S. Treasury Note. While attractive to borrowers, low interest rates are a problem for fixed income investors who want interest income and capital preservation rather than growth and capital appreciation.
Moving into summer, the Fed will want to see real growth in Gross Domestic Production (GDP), labor force participation rates and wages before thinking about raising rates. Strong data in these areas would imply a healthy economy and may even hint toward inflation. Current data does not indicate that our economy is overheated and therefore doesn’t warrant higher interest rates to slow things down quite yet.
It doesn’t always make sense to follow the crowd. In 2011, many experts called for short-term interest rates to increase. When that didn’t happen, they called for rates to move in 2013 and when that didn’t happen, they were certain to rise in 2014. So here we are in 2015 with rates effectively at zero. That must mean that rates will increase this year, right?
Maybe, but not necessarily today. The January 2014 Wall Street Journal Economic Forecasting Survey published in January 2014, predicted that the10-year Treasury note would yield 3.52% at the end of 2014 while it actually ended the year at 2.17% for a 38% difference. These experts also projected crude oil to close out the year at $94.65 when it was actually $53.27 per barrel, off by 44%. The Wall Street whiz kids expected inflation to top off at 1.9% while it was 1.3% at year-end or 32% less than predicted. As you can see, there can be significant differences between expectations and reality.
The unexpected sharp decline in oil prices is a windfall for consumers. Falling energy prices redistributes wealth from energy companies to individual households who’ll likely spend and save more because of the lower prices at the pump. In round numbers let’s assume 253 million vehicles in the U.S. each driving an average of 13,500 miles per year getting 20 miles per gallon. A $1.00 per gallon drop in gas prices saves U.S. consumers over $250 billion or $988.14 per vehicle annually. Lower gas prices fuel consumer spending which leads to job and wage growth.
In contrast, the other wildcard–a strong U.S. dollar–reduces the cost of imports and makes U.S. exports more expensive to other countries. This could potentially reduce earnings of U.S. multinationals and possibly hamper wage and job growth in the near term.
Any change in interest rates will depend on the true rate of economic growth and inflation. The Fed target for inflation is 2%. Core inflation, excluding food and energy components, is currently around 1.3%. Before raising interest rates, the Fed would like to be reasonably confident that inflation is trending towards the 2% target.
Because there will always be economic wildcards and we don’t know how long each situation will last, a methodical approach keeps investors from overreacting based on fear and emotions. Rates will rise, and they will fall. Knowing what you own, why you own it and how various economic events will likely affect your goals are the keys to success. “Stay focused and invest accordingly.
The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed.
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This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. Call or email Darcie at 239-389-1041 or firstname.lastname@example.org with questions or suggestions for future columns. Visit her .website: www.raymondjames.com/Darcie