Volcker and Government Programs – what does it mean to interest rates?

Okay, here’s basically what Paul Volcker is saying:

• The government needs to start unwinding the “bailout” programs that it has done and it needs to do that before it looks like they need to, not after we can all see that we need to.
• If we wait until we can see that we need to do it, it’s too late and the problems are going to get out of control “on the other side.”
• He’s got a lot of credibility in this area because he is the guy who gets credit for stopping inflation back in the early ’80’s but he had to raise rates to 20% to do so.

So what does that mean to interest rates?   Particularly the rates that we’re most concerned with, mortgage rates?

A couple of thoughts:

• If the government unwinds their programs (the free money, the ultra low interest rates, etc.) in a systematic and measured response and starts doing so before inflation becomes an issue, I expect that we’ll see interest rates go up by a substantial but rational amount.
• If the government doesn’t unwind their programs until after inflation becomes an issue, then we’re going to see the entire interest rate market get hammered and we’re going to see the Fed have to raise short term rates a LOT higher than they would if they have a reasoned and proactive approach to it.   This in turn will put a LOT of upward pressure on mortgage rates and I expect we’ll see rates that will make us long for the days of 6 and 7% rates again.

Let’s face a couple of realities of the markets:

• Money can’t stay “free” forever.   Rates are going to go up – the only question is by how much.
• When someone borrows money, they eventually have to pay it back.
• The greater the risk of inflation, the higher the rates are going to be.
• The more proactive the government is fighting inflation, the lower rates are going to be.

If you want to talk about this or about anything else, feel free to call me at (616) 292-7559 or e-mail me at tvanderwell@straighttalkaboutmortgages.com.

Thanks,

Tom Vanderwell
Fed Can’t Wait Too Long for Policy Shift: Volcker – General * US * News * Story – CNBC.com

The enormous amounts of liquidity pumped into the U.S. financial system by the Federal Reserve are not inflationary “at the moment” but will become so at some point, Paul Volcker, the former Fed chairman and a White House adviser, said on Thursday.

Volcker, now an economic adviser to President Barack Obama, said it was difficult, but necessary, to start draining the billions of dollars in liquidity even while unemployment rates remained high as the U.S. battles out of recession.

“You have to act against what seems like common sense. If you wait, it’s too late,” Volcker said while answering questions after a speech on financial markets at Harvard University’s Kennedy School of Government.

Volcker is best known for bringing down raging inflation in the United States after he was appointed Fed chairman in 1979 — chiefly by pushing the federal funds rate, the central bank’s key policy tool, to a peak of 20 percent in 1981.

Technorati Tags: Interest Rates, Mortgages, Paul Volcker

When should the Fed raise rates? (Hint – what I’ve been saying might be early…..)

An interesting analysis of what the Fed should do and when they should start raising rates.   A couple of thoughts about it:

• Krugman, in saying that short term rates should say on hold for at least two more years, admits he’s using standard conventional analysis of the numbers.
• The standard, conventional analysis of the numbers doesn’t take into consideration the impact of what the government has done in borrowing boatloads of money in an effort to keep the economy moving.

So, would I be willing to guarantee that Krugman is right?   Nope, not a chance.   But given his track record, it seems to me to be significantly more likely that rates will stay the same (short term rates that is ) for longer rather than shorter time periods yet.

I’m still sticking with my 12 to 18 month estimation but this is pushing it out towards the 18 month end of things.

Tom Vanderwell
When should the Fed raise rates? (even more wonkish) – Paul Krugman Blog – NYTimes.com

Even so, unemployment should fall only 2.5 points, to 7.3. In other words, even with a really strong recovery (which almost nobody expects), the Fed should keep rates on hold for at least two years.

Technorati Tags: Fed, Paul Krugman, Interest Rates

Why we don’t have to worry about the Fed raising rates soon…..

Below are “snippets” of an article written by Mark Thoma about a speech that one of the Federal Reserve’s Board of Directors made.   A couple of things that are “worth noting:”

• There is virtually no upward wage pressure right now and that type of “non-inflation” is going to keep the Fed’s rates low.
• The situation is not going to change dramatically.    This article estimates that it will be well into 2010 before we see the real opportunity for the Fed to start raising rates.

Like I’ve said before, in my opinion, we have 12 to 18 months before rates start heading substantially upward and in my opinion, any debt, consumer or mortgage or business, that isn’t going to be paid off within 2 to 3 years should be moved over to as long of fixed rates as are currently available.

When it does rebound, it will rebound quite dramatically, but that’s not yet…..

Tom Vanderwell

Economist’s View: Fed Watch: More Confirmation of Steady Monetary Policy

The weakness of labor markets has virtually eliminated upward wage pressure, and wages and compensation are steady or falling in most Districts; however, Boston cited some manufacturing and business services firms raising pay selectively, and Minneapolis said wage increases were moderate. Boston, Cleveland, Richmond, Chicago, Dallas, and San Francisco cited a range of methods firms are using to limit compensation, including cutting or freezing wages or benefit contributions, deferral of future salary increases, trimming bonuses and travel allowances, reducing hours, temporary shutdowns, periodic furloughs, and unpaid vacations.

Until economic growth is sufficient to propel wages upward, any residual price pressures are likely to be snuffed out by deteriorating real wage growth. Will the job market improve anytime soon? We get a fresh look at initial unemployment claims tomorrow morning, but the July consumer confidence report from the Conference Board indicates that households see a deteriorating jobs picture:

The share of consumers who said jobs are plentiful dropped to 3.6 percent, the lowest level since February 1983. The proportion of people who said jobs are hard to get climbed to 48.1 percent from 44.8 percent.

Lacking a story that leads to strong wage growth in the near – or even medium – term, the Fed is almost certainly on hold at least through this year and likely well into 2010, allowing the size of the balance sheet to adjust according to the needs of the financial markets while keeping interest rates at rock bottom levels.

The Fed

Bernanke and Rate Hikes

So we’ve got a 60% chance the Fed will raise rates in January and a 100% chance by March.   Guess what, that’s not the big issue.   In my mind, we’ve got 12 to 18 months before we’ve got any substantial issues as far as interest rates.   But then we’re going to see some really big challenges.   More on that later.

Tom Vanderwell

Rate hike odds post Bernanke testimony | The Big Picture

Following two days of testimony (and the WSJ editorial) from Bernanke where he repeated that interest rates will stay low for an extended period of time, that inflation will remain subdued for a few years more and that unemployment will remain elevated for a period of time, the odds of a year end rate hike are down to 13% from 27% one week ago and 46% one month ago. A 25 bps hike to .50% is not fully expected until the March ‘10 meeting. The January ‘10 meeting rate hike odds are at 60%. In the discussion on exit strategies too over the past few days, ending QE and many of its liquidity facilities will be a cake walk compared to normalizing the fed funds rate in terms of its impact on the economy.

Bernanke, Interest Rates

Interest Rates and the Fed…..

There are a couple of things that really concern me about this article…..

• The Fed Funds market has priced in a 48% chance that prime rate will go up by .25% in September.   That’s a dramatic switch from even two days ago and really illustrates what a dramatic upheaval the bond and interest rate markets are undergoing.
• When you get a member of the Federal Reserve standing up and saying, “you know, we didn’t really know what would happen when we started buying Mortgage Backed Securities to try to keep the market going.”

Well, guess what, we’re finding out the longer term effects of it right now, and they aren’t pretty.

Tom Vanderwell

Treasuries/Fed policy/Uh oh | The Big Picture

……The fed funds futures are pricing in a 48% chance of a 25 bps rate hike by the Sept meeting and that is up from a 2% chance priced in just yesterday……
…..Using quotes from DJ, she said that while buying MBS and US treasuries got off to a good start with yields heading lower, “there’s a lot that central bankers don’t know about the magnitude and duration of the effects of these policies” and “our standard monetary policy models do not incorporate financial frictions that lead to asset purchases having real effects.”…….

Interest Rates

Bernanke hints at rate cut – Nov. 14, 2008

Warning that financial markets remain under “severe strain,” Federal Reserve Chairman Ben Bernanke pledged Friday to work closely with other central banks to fix global financial problems and left open the door to a fresh interest rate cut to help brace the sinking U.S. economy.

Bernanke hints at rate cut – Nov. 14, 2008.

News Flash!  The Fed’s going to cut rates again.   Of course he is.   The financial markets and the economy are on rough footing so he’s got no choice to do that.

But he can only go down by another 1% and then what?   I’ll have some more thoughts about that later (hopefully some time next week) but let’s just say a couple of things:

1. A rate cut won’t solve the problems that the economy has.
2. A rate cut of the shortest of the short term rates won’t help long term rates, it might even make things worse (push rates up).

Tom Vanderwell