Tag Archives: Interest Rates

Business Investment is Falling

Thesis: Now is the time for companies to invest in themselves given the upcoming rise in treasury yields.

Many companies have slowed investing considerably this winter. This is not surprising given what has been occurring on a macro level. The value of the dollar is rising and the overall world economy is struggling. These things coupled with hurting US energy sector has most likely contributed to these figures. According to recent reports, the demand for investment in non-defense capital good excluding aircrafts fell 1.4% from January. This is after we saw flat growth for the first two months of the 2014.

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According to experts, “Weak business spending—along with other factors like a downbeat export picture—prompted some economists to downgrade their assessments of how much the economy expanded in the current quarter. Morgan Stanlety said it now thinks gross domestic product grew at a 0.9% annual rate in January through March instead of its prior estimate of 1.2%. Macroeconomics Advisers lowered its estimate a tenth of a percentage point to 1.4%. http://blogs.wsj.com/economics/2015/03/25/weak-demand-strong-dollar-u-s-businesses-arent-investing-much/.  This is why I believe now is the time for companies to engage in serious capital expenditures. The US economy has been performing well relative to the rest of the world. Interest rates are due to start increasing as we have seen with this graph provided by FRED.

fredgraph

 

The Fed has recently announced they will most likely being raising interest rates this year after many years of keeping them as low as possible to spur investment. This is why now is the time for companies to invest in themselves. In as soon as this year, the cost of borrowing could become a lot more expensive, leading to potentially lessened profits for companies. Federal Reserve vice chair Stanley Fisher said, “It will likely be appropriate for the Fed to raise rates this year, but said rate increases won’t followed a predictable or necessarily steady course once the Fed begins lift-off.” http://www.businessinsider.com/stanley-fischer-fed-speech-2015-3. This unpredictability is another reason why now is the time to invest. Capital expenditure is a key driver of revenue growth and can be the difference between sustained long term growth or stagnation. If companies are not able to invest in themselves and buy new plants, property and equipment (PP&E), then they can not grow and build revenue. While some companies may counter this by saying they can cut costs and improve the efficiency with how they operate, I say good luck. These kind of management strategies are good in the short term but are not sustainable. At some point, investment is necessary. While rates are expected to increase, this does not mean they will shoot up overnight. It is necessary for companies to begin building a plan and capex schedule for the next 10 years so they are able to prepare for this increase. Many companies have gotten comfortable with these low rates and may be dealt a major blow when this increase occurs. Hopefully companies are prepared and are able to adjust properly to whatever action the Fed takes. If not, it could mean trouble for GDP growth over the next few years.

 

Fed Stalls Raising the Short Term Interest Rate

Today at the FOMC meeting, the Federal Reserve released statements that were more dovish than analysts had expected regarding the short term interest rate. On February 7, I posted a blog highlighting my analysis and contrarian view that the Fed would stay patient in raising the short term interest rate despite popular beliefs it would come sooner rather than later. Now I am not saying that I have achieved victory in my prediction, but it is one step closer in the right direction. My prediction came at a point after a point when the most recent U.S. economic data was strong. The Fed minutes suggested that U.S. data was weak according to a report by the Wall Street Journal: “The action followed a round of soft economic data and signs from the minutes of January’s Fed meeting that the central bank is grappling with how to lift U.S. rates for the first time since 2006.” That is a long time period since the Fed last raised interest rates, and there are many new factors in play considering we have experienced the Great Recession and experimented with new forms of monetary policy.

Raising interest rates has many negative implications. Domestically, it makes it harder to borrow in the sense that debt is relatively more expensive. Say you have a floating rate mortgage and today your payment is 4%, your payment might go up substantially if the mortgage rate moves to 6%. Also, there are more first time home buyers that may not be able to afford a house if their mortgage payment is higher due to the rise in interest rates. These are only a few sheltered examples related to one industry that would be negatively affected by a rise in interest rates. An interest rate increase also has some positive effects, too. Another Wall Street Journal article highlighted the market effects due to interest rates being held lower. “The yield on the two-year U.S. Treasury note fell by about 0.07 percentage point Wednesday to 0.605%, the biggest one-day decline since August 2011. The yield, which falls as prices rise, is among the most sensitive to changes in the Fed’s interest-rate outlook.” Essentially, investors earn less return on their money when interest rates are low.

Another negative of raising the interest rate arises in international finance. When the Fed raises the interest rate, that will lead to a decrease in net capital outflows, and an increase in the U.S. dollar exchange rate. The increased exchange rate can be viewed as a positive since it signals a strong economy, but will ultimately hurt net exports. This dilemma can also be viewed from the net capital outflows decreasing according to the equation NCO=NX. Essentially, net capital outflows are equal to net exports and boost a country’s GDP. So when net capital outflows fall due to an increase in the interest rate, the U.S. GDP is also expected to be weakened.

 

Fed Stands Pat on Interest Rates

In a recent Federal Open Market Committee meeting, the Federal Reserve issued its latest statements regarding the status of the U.S. economy and where it sees the future of interest rates. An article published by the Wall Street Journal outlines the FOMC minutes and the Fed’s current stance on monetary policy. The Federal Reserve had announced at earlier meetings that it had intended to raise interest rates in 2015. Some analysts predicted it would be early 2015, while others viewed a potential rate hike as late as Q4 2015 or even early 2016. The Fed reiterated its stance that they seek to raise interest rates around mid-year 2015. So at the earliest, we would expect the Fed to raise interest rates at their June meeting. The FOMC minutes was also comprised of language that indicated the Fed was open to being patient and seeing how global economic events panned out prior to raising rates. The Wall Street Journal coined this as a “wait-and-see” approached.

There are many recent global events to be considered for the Fed to raise the interest rate. Over the past few months, the U.S. dollar has been surging against other currencies due to the strength of the U.S. economic recovery, end of quantitative easing, and hawkish comments made on raising the interest rate. At the same time, other countries including Japan and the Eurozone have embarked on further quantitative easing programs of great magnitude. The combination of strong U.S. dollar and quantitative easing in foreign nations make U.S. exports look relatively more expensive which could put a damper on the U.S. economic recovery. Raising the interest rate would only make the U.S. dollar even stronger relative to its peers, which could have a snowball effect on U.S. exports. Furthermore, the Eurozone was hawkish last year and raised their short-term interest rate as leaders of the European Central Bank viewed the European recovery as solid and were afraid of rising inflation. Now, the bloc of countries is at risk of falling into another recession and has launched another quantitative easing program.

There are risks outside of the monetary policy of other nations, as well. Raising interest rates is a way to combat rising inflation. According to the Bureau of Labor Statistics, the Consumer Price index ex food and energy is at 1.6% which is below the 2% target inflation rate set by the Fed. If the Fed did take the stance to raise interest rates, we would expect to see the CPI drop even further and not be at an optimal inflation rate. I agree with the Fed’s stance to take a ‘wait-and-see” approach. I do think however, that the Fed will remain dovish and that we will not see interest rates raised until the end of the year. There are too many variables that side against increasing the short-term interest rate right now or even in the coming months.

Get Zero Interest Rates Till June!

The Fed held its FOMC meeting this past Tuesday and Wednesday, January 27th to the 28th of 2015, discussing several different aspects of monetary policy to “foster maximum employment and price stability.” Lately, there has been a lot of talk about a rumored interest rate increase that is forecasted to occur sometime this year. Fortunately, the Fed has decided to leave interest rates where they are on account of the falling inflation rates throughout the US, for which they listed several reasons. They spoke on the falling oil prices, the ECB’s decision to buy over a trillion Euros worth of bonds, and the dollar’s appreciating value. Ultimately, interest rates are still expected to increase in June of this year, and many still fear this day.

A USA Today article titled “Fed likely to continue to signal mid-2015 rate hike” states “The Fed typically raises interest rates to keep inflation from spiraling too high as the economy and labor market heat up and lowers rates to spur growth. The unemployment rate has fallen from 6.7% to a near-normal 5.6% over the past year, providing support for adhering to Fed policymakers’ forecast for the first rate hike in June.” Should the Fed increase interest rates, many negative events may occur. The most likely result of this increase would be an immediate shock to the stock market. Investors like conditions where money is cheap, and higher interest rates mean it is effectively more expensive to borrow. The same goes for mortgages, loans, and credit. People would ultimately see a decrease in the purchasing power of their dollars, and a rise in prices everywhere. Historically, higher interest rates have been signs of an economic recession, however the Fed doesn’t have much of a choice.

Some expect that the Fed shall continue printing money and buying securities to keep interest rates artificially low. That is entirely within the realm of possibility, however eventually the Fed has to raise interest rates or inflation will devalue the dollar to a worthless status. It’s going to be a risky decision for the Fed, and had they raised interest rates a long time ago, it may have been a smarter move. Economic crashes have always occurred cyclically. Never for the same exact reason, always the same way. As with the 2008 subprime mortgage bubble, we are now faced with an even greater bubble that must be deflated. What remains to be seen is which needle the Fed chooses to use this time.

The Waiting Game

“The Federal Reserve signaled this past week that it is unlikely to raise short-term interest rates until at least June” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

This came as a surprise to most people, it seems, but I am not completely surprised based on the underlying motivation of the Fed.

“…The Fed will raise interest rates only when it is confident that the economic recovery is robust and companies have regained the ability to raise prices” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although it seems that the Fed is not in touch with everyday citizens, like you and I, I believe their decision to delay the rise of interest rates is in tune with the best interests of everyday citizens. Although we have been told for a while that the recession is over, it seems that from the perspective of everyday people that is not necessarily the case. It seems like the wealth of the upper class has been rising since post recession, but the middle class and below has not had the same fortune.

The Federal Reserve clearly believes that the economy is not in full rebound yet, hence the delay of raising rates until mid summer. I am happy with the decision the Federal Reserve made, their focus seems to be more on the well being of everyday Americans, rather than worrying about creating high returns for investors. This is not really the common perception of the Federal Reserve; most people seem to think they do not have to best interest of the people in mind. There seems to be this notion or belief that the Federal Reserve is just a group of wealthy bankers in an ivory tower playing with everyone’s money, acting according to the best interest of a few. Their recent decision, however, points to the opposite.

“…Investors seemed mildly disappointed when the Fed reiterated on Wednesday that it would remain “patient”” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although investors seem to be upset with the Federal Reserve’s decision. Most people are not investors so this decision by the Fed to not act does not affect them in the same way as those who speculate based on the Fed’s actions.

“More than three-quarters of Americans say the five-year bull market in U.S. stocks has had little or no effect on their financial well-being, according to a Bloomberg National Poll” (http://www.bloomberg.com/news/articles/2014-03-12/stock-market-surge-bypasses-most-americans-poll-shows).

Bull market is a term used to signal positive beliefs about the market, while bear market is used to signal the exact opposite, pessimism towards the market. Although the stock market, like explained above has been labeled a bull market for the past five years, this has not improved the financial well being of everyday Americans, most who do not own stocks, or at least not a significant amount anyways. With the lower and middle class of America still struggling, it seems that the fed made the appropriate decision to delay raising interest rates.

“Don’t worry about the Fed; be happy” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

You can be happy; the Fed seems to be thinking about you and I, not just the wealthy elite.

Fed Remains on Track, Remains Patient

The Federal Reserve had their first meeting of the new year on January 28th. The meeting did not yield too much news as the Fed announced they would stay on track for raising short term interest rates starting this June. The summer of 2015 has been the expected time the Fed would being to raise these short term rates. However, due to recent slowing inflation, many investors feel that the Fed will not raise rates until this fall. These near 0 short term interest rates have held steady for six years as the US economy continues to recover from its greatest recession since the Great Depression. The Fed was overall very optimistic about the economy given solid economic and job growth. These strong numbers coupled with falling oil prices and rising consumer confidence were enough to offset the inflationary concerns, enabling the Fed to keep summer 2015 as their goal. One of the Feds main jobs is to control for inflation. I believe this role will make the Fed wait until the fall to begin raising rates unless something remarkable happens in the next six months. The articles notes, “The Fed’s stated goal is to keep prices rising at an annual rate of about 2 percent, part of its effort to support economic growth and grease the wheels of commerce. But it has not hit that target in more than two years, and it is increasingly unlikely to achieve it this year.” http://www.nytimes.com/2015/01/29/business/federal-reserve-rate-decision.html?_r=0. With the eurozone and emerging markets struggling, their is no need to rush into raising rates. The US has shown strong growth the last couple years and it would be idiotic to rush into things just to “stay on track.” These inflationary concerns are most likely due to falling oil prices and not an overall sign of economic weakness. The Fed is remaining patient and said they will continue to monitor the state of the economy before the rush into a decision. Regarding the long term, the Fed said, “Even after employment and inflation get to their targets, economic conditions, may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” http://www.businessinsider.com/federal-reserve-announcement-january-28-2015-1. This Fed announcement will most likely continue to spur economic growth. If the Fed came out and said they saw signs of economic weakness, that could potentially be detrimental to economic development and consumer confidence. While I never think the Fed would actually say something that frank and blunt, they could have beaten around the bush. Fortunately, they, along with with many experts, view the US economy as strong as it continues its recovery. If the Fed said they thought the economy was doing so well they would start raising rates next month, that could also hurt the US economy and confidence. When the Fed does beginning raising rates, I expect the market to go down as investors becoming frightened about the unknown future. These are uncharted waters the Fed and US economy are navigating right now. Hopefully the Fed has been thinking ahead and is able to raise rates without harming the economy and confidence. Overall, this recent Fed announcement was positive as it indicated the Fed was on track with its plan to raise rates starting this summer.