The Federal Reserve is expected to raise interest rates Wednesday by 25 basis points, to 1 percent, and the U.S. central bank has indicated it plans to raise rates aggressively. Most economists expect the Fed to continue raising rates until short-term interest rates reach 2.5 percent.
Although the decision was widely expected before, Friday’s jobs report from the Labor Department provided further reason for raising rates. Nonfarm payrolls increased 235,000 from January, and the unemployment rate declined slightly, to 4.7 percent. The job market also showed signs of tightening, with average hourly earnings rising 2.8 percent over last year.
Few economists expect yields to approach the levels they attained when I was involved in the fixed-income markets, from 1969 to 2005. Then they often exceeded 5 percent, which we have not reached since 2007. Under then Federal Reserve Chairman Paul Volker, the Fed’s benchmark exceeded 20 percent in the 1980s!
Fed Chairwoman Janet Yellen said last month that, assuming employment and inflation evolve in line with the Fed’s expectations, raising the Federal Funds rate would be appropriate. Other Fed board members have supported her comments.
Why have rates been so low? To stimulate borrowing by the private sector. When the economy collapsed in 2008, the Federal Reserve needed to get private businesses to feel comfortable borrowing and reinvesting in new factories and equipment. When companies expand, they hire more people, who spend more and this lifts the economy.
Today, we might be on the brink of a different problem: Since unemployment is low and certain sectors of the economy have expanded as much as they can for now, the concern now becomes an overheated economy in which prices become inflated. To prevent overheating the economy, the Federal Reserve needs to raise rates so companies will slow their expansion. The Fed seeks to find a middle ground, where unemployment remains low and the inflation rate is 2 percent.
On CNBC, investor David Tepper argued that the Fed needs to increase interest rates to prevent the economy from overheating. He also expressed confidence that the economy could grow by 3 percent. He based his optimism, in part, on having a GOP president and majorities in the House and Senate, which would end “business-zapping” regulations.
Most retirees would welcome an increase in rates. One-year CDs have not paid 1 percent since 2009, according to Bankrate.com. Swiss Re estimated that the low level of rates since the 2008 global financial crisis have cost U.S. savers almost $1 trillion in lost income from a broad range of fixed-income securities.
Low interest rates have forced retirees to abandon what had been considered a rule of thumb. Financial planners had suggested subtracting an investor’s age from 100 to ascertain what proportion of savings to allocate to stocks. I and nearly all of the people I know have much more than 50 percent of our investments allocated to equities. To modify our risk somewhat, we have invested in stocks that yield more than 3 percent, which exceeds the current rate on the 10-year Treasury note by 50 basis points.
Lawmakers such as U.S. Sen. Bob Corker, R-Tenn., have been critical of low interest rates. Corker in 2013 accused then-Federal Reserve Chairman Ben Bernanke of “throwing seniors under the bus.”
While 10-year Treasury notes have risen since the November election to 2.6 percent, this rate is still below their 2.9 percent level when U.S. stocks hit their low on March 9, 2009. The stock market has risen threefold.
I welcome a return to short-term rates reaching 2.5 percent because our low-rate environment has penalized savers severely. I am concerned that many people of my age group have relied too heavily on equity investments. And we hear frequently from business leaders and investors who are skeptical that we have fully recovered from the Great Recession until we return to interest rates near the historical norm.
I worry that unless we impose some interest-rate discipline, inflation could exceed the Fed’s target of 2 percent. Higher inflation historically has wreaked havoc on business investment and long-term savings.
Originally published in the Sarasota Herald-Tribune
