There is an old saying that “talk is cheap.” Right now, we are hearing all of the talk that the Fed is going to start to raise interest rates and tighten monetary policy as the economy strengthens.
I for one am very weary of this talk. Firstly, the Fed’s own history does not back this up. In the last recession, the Fed did not begin to raise rates until 2004 — nearly three years after the recession ended, in the fourth quarter of 2001. And they did so at an extremely slow rate. The Fed never really “took away the punch bowl.” Instead, they kept printing money and increasing the money supply during. This helped fuel the fire of the housing bubble.
Now the Fed has again cut rates to near zero. They have trillions of dollars of mortgage-backed securities on their books. By some accounts, the Fed is leveraged as much as 43 to 1. Lehman Brothers at its peak was leveraged 39 to 1!
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A lot of the securities they own depend on rates staying low. I do not see them raising rates and bankrupting themselves (Remember, when you are leveraged 43 to 1, a 2.8 percent drop wipes out your capital). Also, employment will be slow to rebound during this recovery. I do not see them really raising rates until jobs grow again.
The Fed already is behind the curve. The yield on the 10-year Treasury is up from a low of 2.07 percent reached in December 2008 to 3.78 percent at the moment. Yet it has kept rates at near-zero levels.
This is a historical precedent for this as well. When the economy blew up in the 1930s, the prime rate dropped from 6 percent in 1930 to 1.50 percent by the middle of the decade. It then sat there by 10 years. After World War II, inflation reached double-digit levels yet the prime rate still only increased to just over 2 percent by in the late 1940s!
Talk is cheap. People can talk about higher rates all they want. History tells us, though, that the Fed will remain behind the curve and keep rates at below-market levels for an extended period of time — as they keep telling the market with nearly every breath.
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