What will happen this year and what will happen next
Published: September 25, 2015
JORDAN DEN HERDER
For some time now Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, has
been claiming that sometime this year the Federal Bank will be raising interest rates. This action has been postponed continuously due to poor circumstances in the world economy.
Most recently, the jolt in China’s market has held the FED off the hike. Since the world economy is fragile and investors are skeptical because of the plunge, an interest rate increase could very well send people into panic mode.
On the other hand, the market will never be in an ideal situation to raise rates, which have been near zero since the market started recovering from the 2007-2008 collapse. Analysts are concerned that if interest rates are not increased even a little bit, it could seriously hurt our economy in the long run, despite the people who would fight it.
There are both pros and cons that would result from a hike in interest rates.
The market has been relatively healthy for six years now, the Dow Jones being up 148 percent, the Nasdaq up 273 percent, and the S&P up 187 percent, numbers which include the dip seen in the past few weeks. An interest rate rise could psychologically indicate to investors that our economy is healthy enough and that near zero rates are not necessary for U.S. growth any more. Higher interest rates will also boost value stocks. For the past few years a majority of market growth has been from growth stocks. However, if interest rates are lifted even a little bit people will suddenly realize which equities are the most financially stable.
Many people are more scared of the slight change in the economy rather than the actual rate hike itself, which would most likely be done very gradually, in turn not making very many waves. In addition, interest rates cannot remain so historically low forever; Fed stopped quantitative easing last year in order to change that. Many analysts are fearful that with everyone so willing to spend and invest their money due to the low interest rates, another bubble could appear and overinflate our market, inevitably leading to another crash like that of 2007-2008 or possibly what is happening in China right now.
No one likes to see slowing growth in the economy, especially investors, which is why popular opinion supports keeping interest rates down. An increase in rates would foremost increase the cost of borrowing, leading to fewer loans. The number of car loans, mortgages and long term investments would decrease. More and more consumers would fall back on saving their earnings, in turn, decreasing a large part of consumer spending and hurting the country’s GDP.
“This would especially hurt the housing market since it has not fully recovered from the collapse in 2008,” cautioned Riaz Hussain, Ph.D., associate professor of finance at The University. Many people remain skeptical about the housing market, especially because Real Estate Investment Trusts (REITs) have slumped recently, particularly the Dow Jones Equity REIT and Vanguard REIT which are down 10.4 percent and 11.1percent respectively since mid-August.
Hussain advises against higher interest rates, explaining how “low interest rates are very beneficial to the economy,” as they keep consumer spending up and provide economic growth on many levels. “The economy is starting to slow down as it is, so raising rates now wouldn’t be the smartest idea,” Kevin Munns, a junior, stated. Junior Abigail Hatch agreed, saying that, “(The) state of the economy has been pretty average therefore the FED’s focus should be facilitating on behalf of investors to keep the market’s growth positive.”
Many are worried that the rate hike might be too soon and dangerous in an unstable world economy, while others are confident that rates have been too low for too long.
When Chairwoman Janet Yellen took the podium at this month’s press conference last Thursday, those anxiously awaiting her message were entirely unsure of what she was going to say. When she finally delivered it she managed to increase rather than diminish people’s anxiety.
Yellen explained that the Committee had decided it would be best to hold off on changing interest rates at the moment due to a couple of factors. First, that even though the market has been growing, the recent level of growth has been fairly low, a statement in agreement with the previous comments of Munns and Hatch.
Secondly, to no one’s surprise, Yellen explained how recent volatility caused by China has deterred the committee from rising rates right now.
Lastly, the ideal level of inflation in the FED’s eyes is two percent, and thus far, the U.S. has only achieved 20 basis points, or two tenths of a percent, since January. Being up 20 basis points is much more favorable than having negative growth or shrinkage. However, with this miniscule growth of inflation, any rise in the interest rate, no matter how slight could almost immediately negate this year’s increase and bring inflation to historically low numbers.
There seem to be two major factors that have contributed to keeping inflation so low. First off, the strengthening of the U.S. dollar has led to a decrease in exports, as other countries are buying less from the U.S. due to the increase in price. This strengthening in the U.S. dollar was caused mostly by the fact that the U.S. economy has stayed strong while other economies have begun to sputter, or even crash, such as certain European countries. The second factor keeping inflation down is the low price of crude oil. Because the price of crude oil is so low, Americans are not spending as much money in a specific major section of the GDP energy.
The idea that two major factors in the GDP were lowered may lead some to expect that the nation’s GDP shrunk. In reality, it is quite the opposite. GDP growth for the first half of the year was two and a quarter percent. These numbers put the economy on track to have a good year.
In addition to GDP growth, the labor market added about 220,000 new workers per month in the first two quarters. This means that unemployment is projected to be as low as 5 percent by next year. This is astonishing, given that at the start of the year, unemployment was at about 6 percent.
Between the expected good GDP growth and the low unemployment, it seemed as though the market was begging for rates to be increased. Yellen claimed that the committee is waiting for a rise in inflation rates and unemployment numbers to fall even more. Once they feel a bolstering in confidence brought about by the above factors, they will strongly consider raising interest rates.
University alumnus and recent Goldman Sach’s vice president Joe Vaszily expressed his feelings on the subject, saying that “the market was ready for an increase” in rates on most cases, but since they did not raise rates this time around, the next probable timeframe would fall around their meeting in March 2016. Marc Palucci, a first year finance major, similarly said, “I don’t really know when they’re going to do the actual raising, but I assume it will be sometime after the holiday season.”
The recent situation the Federal Reserve was placed in is unique on many levels. The FED’s mandate is to encourage strong and sustainable growth, moderate for inflation and maintain high levels of employment. The economy right now is said to have strong economic growth and low unemployment, indicating our low interest rates. The twist comes in with inflation, which boasts being at a low 0.2 percent, a statistic that indicates that right now the U.S. has high interest rates. There has also been talk that unemployment is not as low as it seems and that the labor force participation rate is decreasing, resulting in seemingly low unemployment. But this, too, would indicate that interest rates are high right now. Understanding this predicament, if rates were raised, inflation would fall past its already dangerous levels, and unemployment would increase further (it is estimated to be at 9.6 percent using the labor force participation from 2009). At the same time, the economy seems to be at decent levels, something that would most likely change if rates were raised. This being said, the FED did not have an easy decision to make last Thursday given the current conditions in the U.S.
Despite the thoughts of analysts, critiques and applause alike, the federal interest rate will stay low for now, and perhaps more light will be shed on the subject in the October and December meetings.