Fed Watching: No Interest Rate Hike on the Horizon

Well Fed watchers for the year have hyped up the possibility of an interest rate hike in September.  Last week, the Fed voted to hold rates where they are.  The last interest rate increase by the Federal Reserve was in 2006. So we have gone nearly a decade without any sort of increase in rates from the Federal Reserve.  We have lenders working today, who have not experienced any impact from increasing rates as a result of Fed policy action.  It kind of makes one wonder if this will be how things are for the foreseeable future.

Fed Chair Yellen cited that while the recovery from the Great Recession has advanced sufficiently, there were enough uncertainties in the world and a less inflation than the 2% range, which is where the Fed would like to see it.  Inflation was recently reported at 0.2%, and has not exceeded the 2% threshold since 2012.  She also mentioned weakness in the labor market as a factor to hold off on increasing rates.  There are high levels of part-time involuntary employment and a very low labor force participation rate in our economy.

Other factors are weakness in economies and markets throughout the world.  This has helped lower import prices and also risen the value of the dollar in comparison to other currencies.  A rate hike at this time will strengthen the dollar more, which will make US exports less competitive on the world stage. Yellen mentioned concerns about China 16 times during her press conference wrapping up the Fed meeting. 

The challenge with the Fed’s continued zero interest rate policy (ZIRP) is that it leaves very few monetary policy options available if there is some sort of severe downturn in the economy that could use some intervention from the Fed.  Also, would any rate hike result in a pullback in the markets and the economy, taking us past the point of slowing down economic growth to a full-fledged recession?  And would pumping additional money into the economy just swell the already bloated debt market?

But ZIRP can be here to stay for a while.  When Yellen was asked if the Fed could be locked into a box where rates never escape from zero, Yellen said she could not rule it out.  Former Fed Chair Ben Bernanke was reported by Reuters last year that he did not expect rates to normalize in his lifetime. 

One factor that is not often discussed in its role in our economy is the impact of demographics.  The Baby Boomer segment of our population control nearly 75% of the net worth of the country.  These folks have just begun entering into retirement in 2007.  Over the next 14 years they will retire at a rate of one in every eight seconds.  When folks retire, they tend to spend less on goods and services.  Consumer spending is the largest segment of our GDP.  As more and more of these people leave the workforce, economic activity will decrease and it will become harder and harder to see significant economic growth.

Japan is several decades ahead of us on this demographic curve.  Their baby boomer generation has already entered into retirement.  They have had overnight lending rates at zero for almost two decades.  Their government has been involved in several stimulus projects.  Yet, while sovereign Japanese debt has ballooned to 230% of GDP as the government continues to attempt to grow the economy, economic growth has remained anemic. 

So barring any other new developments, we may be in ZIRP land for quite a while.