US Interest Rates Likely To Remain Low For The Foreseeable Future

December 9, 2013 prolog Comments Off on US Interest Rates Likely To Remain Low For The Foreseeable Future

 While 2013 has been a good year for investors, with the stock market up over 20%, it has remained a miserable one for savers. Interest rates are still stuck at historic lows, making the returns on safe financial vehicles such as savings accounts, certificates of deposit and treasury bonds highly unattractive. Part of the reason for this is the ongoing financial stimulus that the US Federal Reserve continues to pursue, faced with an economy that is still staggering to its feet after the economic shock of the 2008 financial crisis. In effect, the Fed Reserve is killing CD rates and savings accounts rates by maintaining its target interest rate near to zero.

 

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In fact, it had been expected that the Fed would strengthen its guidance on low interest rates even further by lowering the unemployment threshold – the unemployment rate at which the Fed would start to raise interest rates – from 6.5% to 5.5%. With current unemployment rates still at 7.3%, this would have pushed back the prospect of interest rate hikes even further. However, the Federal Reserve Chairman, Ben Bernanke, put paid to this notion in a speech on November 20th. While on the surface this might appear to be a small victory for savers, the only reason that he did this was that lowering the threshold would have undermined confidence in the ability of the Fed to provide reliable guidance going forward.

 

Instead, what Bernanke did was to weaken the linkage between the unemployment threshold and interest rate rises. Specifically, he stated that “the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.” In plain language, what this means is that the Fed is going to continue to keep interest rates low even after it has stopped quantitative easing – printing money to purchase assets – and the unemployment rate has dropped below 6.5%. That places any interest rate increases out in the far distant future.

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Why would the Fed do this, given the negative impacts of low interest rates? Put simply, it still needs to maintain stimulus for an extended period of time. Part of the reason for this is that inflation is still below 1%, which could lead to the sort of deflation that has caused economic stagnation in Japan for over a decade. In addition, real unemployment is higher than the official 7.3% figure – many workers have given up trying to find a job and don’t show up in the unemployment statistics. In fact, this was why the Fed contemplated lowering the unemployment threshold before finally rejecting the idea – it simply reflected the reality that the unemployment rate was understated. In the end, Bernanke simply chose a different way of providing the same interest-rate guidance, while avoiding a crisis of confidence in the Fed.

 

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