Monday, December 7, 2009

Interest Rates to Remain Low for a Long Time

It's odd to see the fear in the markets that interest rates will rise sooner rather then later. If it does rise, it'll only be because of much better economic data including job expansion. As we've reported [Ultimate Leading Indicator: Yield Curve], when rates rise from an extremely accommodative level and a high yield curve its bullish for the markets. In theory, rates are exceptionally low due to a very weak economy and the raised rates are due to the economy being much better then expected. That's bullish for stocks. The issue is when rates are extremely high and then they are raised because of inflation fears. So the level of the starting rate is very crucial.

According to these 2 guests on CNBC the expectation is for rate increases in August 2010 and even later. That seems absurd considering the sub 1% Fed Funds rate. It also highlights the issue with rate policy change. Too much focus is on the trend (increasing/decreasing) versus the absolute number. Raising the rate to say 2% would still be very low on historical norms and likely still conducive to asset bubbles. So why the sweat over the trend? Beats us as any rate increases 6 months from now won't impact the economy until mid 2011. It could easily be late 2011 before the Fed Funds rate hits 3% or the level at which we'd become concerned that rates have moved high enough to crimp growth. A lot depends on how the yield curve reacts.

One of the reasons that stocks have done well in a rising rate environment off a low interest rate base is that companies might look to borrow money and expand sooner before rates rise much higher while in a high rate environment companies probably eliminate all borrowings and expansion plans. The relatively low rates even after 3 or 4 hikes will still lend conducive to high GDP growth at least in the short term. In the last couple of tightening cycles it's usually not until the Fed raised rates 10+ times without even waiting for the impact that the economy got smoked. Does the Fed even understand it's own advice that it takes 9+ months for a rate hike to fully impact the economy?

For now, don't fear rate increases!













No comments: