Interest rates of course affect us all, both as consumers and managers in business. They can make a dream home affordable or forgettable, and with respect to businesses, materially drive current expenses and the potential profitability of future capital investments. What we have witnessed in the past nine years is unprecedented. Today, I‘ll provide a brief overview of the current interest rate environment and the key components behind it, and then recklessly speculate on the future, because if I am going to impersonate an economist, I may as well play the part.
When most people think of interest rates, the Federal Reserve (“the Fed”) comes quickly to mind as the purveyor. The Fed has what is referred to as a “dual mandate” to monitor inflation and attempt to maintain full employment in the economy. As one of their tools for stimulation or restriction in these areas is a fiscal policy of controlling interest rates. The Fed unilaterally has the ability to set and change one rate, known as the Federal Funds Rate. This is a benchmark rate at which the top-creditworthy depository institutions (banks) will charge one another, on an overnight basis. This rate is viewed as close to risk-free as there is, and other rates such as LIBOR, Treasuries, and Mortgage rates directionally follow suit. We have seen the Fed increase this rate twice in a little over a year with stated expectations of further increases.
Let’s give some historical context first. When the recession hit, the Fed was quick to act. They lowered interest rates immediately and began a policy sarcastically known as ZIRP (Zero Interest Rate Policy). At that time, the Federal Funds Rate was literally 0%, and the Fed did not make a move until December 2015.
Source: Board of Governors of the Federal Reserve System
The justification for ZIRP was that credit availability was seizing up and by lowering interest rates, it would increase, or if nothing else lower, the ever-decreasing demand. Has anyone else refinanced their mortgage over the past six years?
Back to the dual mandate. While the duration of ZIRP shown above may indicate otherwise, it is widely regarded as unsustainable in the long run. This is becauseinterest rate policy is a big tool in the Fed’s belt, and once the zero-bound is reached, it’s no longer an option to lower rates as a stimulus. The economic recovery has been a deliberate, sometimes frustratingly slow walk to improvement, but nevertheless, there has been continued improvement. The unemployment rate is at 4.8% (January 2017) and inflation has finally popped his head out of his shell, at a four year high of 2.5%. GDP has been as high as 3.5% in Q3 (1.9% Q4) and most notably the stock markets are at record highs. The last rate increase was in December, moving the targeted range to 0.50%-0.75% and The Fed will be meeting again on March 14-15th.
In my next post, I will touch on the real implications, the potential winners and losers of a rising interest rate environment on both the macro economy and what it means to businesses in and out of the lending arena. I want to be thought provoking and not share all my data and insights at once, as one cannot effectively impersonate an economist without employing the principle of scarcity.
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