Interest Rates Have Nowhere to Go but Up

[Dover]

Interest Rates Have Nowhere to Go but Up

April 10, 2010
Interest Rates Have Nowhere to Go but Up
By NELSON D. SCHWARTZ
Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion program to buy mortgage debt, placing even more upward pressure on rates. ..cont'd

http://www.nytimes.com/2010/04/11/business/economy/11rates.html?ref=general&src=me&pagewanted=print

[JDPriestly]

1. And this will hurt. Higher interest rates push housing prices down.

In the past, interest rates were raised to combat inflation that was attributed to rising wages in turn causing more demand.

Wages are not rising and demand is unlikely to increase very much until the job market improves. The job market will not improve if interest rates on business loans rise.

So, interest rates may have no where to go but up, but, assuming they will eventually rise, they probably will not go up very fast or very far. The economy is not improving that fast.

Unemployment would have to be as low as maybe 5-6% at least before wages would rise enough.

And, as I said at the beginning, the government will not want the interest rates on mortgages to rise very much because the government has a backlog of mortgages and interests in housing to unload. When interest rates rise, housing prices decline -- usually.

That is why it is smart to buy a house when interest rates are high and sell when they are low. Remember that. You can refinance a high interest rate down but you cannot refinance the principle downward.

[Dover]

2. So how will this affect interest on savings and other bank accounts?

Sorry so slow to get the big picture. It seems that lots of people who might normally invest their savings are currently 'liquid' in their assets due to an unpredictable stock market and fear of spending, to name a couple of things.
Of course being liquid has also been costly due the low rate of interest on those assets. The
banks have essentially been using their customer's money for virtually nothing.

It used to be that one could get enough interest on their savings to live off of and/or build for
retirement. Of course in the last decade or so the interest on those accounts has been hovering
in the low digits around 1 - 4%.

[DJ13]

3. Ordinarily that would be correct

But the money supply isnt ballooning so far in this recession, in fact its decreasing faster than the Fed is printing due to the "creative destruction" reflected in the declining assets held by the major banks.

True theres moderate inflation within certain markets (those that are left out of the official stats like food and energy, and impact consumers more than businesses), but theres no real inflation in money supply to warrant increasing interest rates at this time.

[roamer65]

4. The M1 money supply is definitely booming.

According the the St Louis Fed, it has gone from just above $800B to nearly $2.2T in the last year or so.

http://www.shadowstats.com

(See the graph from the St Louis Fed)

This is definitely monetary inflation and is exactly why we see gold and commodities at higher price levels. Same amount of commodities being chased by 3 times the amount of dollars.

[dixiegrrrrl]

5. "When 2 worlds collide" eh?

The "official" economy and the "real" economy.

[Statistical]

6. Short term it will be painful. Long term it will be good.

The "cheap" credit is what hid a decade without wage increases. The middle class became poorer every year due to inflation. However as the third graph shows they didn't feel poorer as they could borrow more and more (to makeup for lack of wages). They could only do so because the carrying cost of that debt fell as the raw value of debt rose.

Obviously that can not continue forever.

You can't have price increases without wage increases. Companies got the best of both worlds by cheap credit. Cheap credit has done more to undermine the financial security of the middle class (not so much the poor they tend not to consume credit) than anything else.

[ParkieDem]

7. Agreed.

There are many factors behind the financial crisis, but virtually none of it would have been possible without unusually cheap credit. Interest rates were held down too much too long, and SURPRISE! We got an asset bubble in return.

Housing prices will probably remain somewhat stagnant as a result, but this is not a bad thing. I am sick and tired of everyone getting all hot and bothered saying that higher interest rates will "kill" the housing market. So what? Way too many people in the past decade or so have been using their home as an investment, not a home. Whatever happened to putting 10-20% down, buying a house on a fixed 30-year note at a reasonable interest rate, and living there for 10, 20 or 30 years? If you're house is underwater in say, year 5, it shouldn't be a big concern unless something happens and you're desperate to sell it. Hell, since so much of your mortgage payment goes to interest in the first several years, you likely wouldn't have built up that much equity anyway.