Monday, March 18, 2013

U.S. Interest Rates to Remain Low for Years

Cyprus is in the news today as its borrowing capacity has hit the proverbial wall, and plans to tax its bank depositors are conjuring up fears of a 'run on the bank.' As a result, these potential runs on Cyprus and other European banks are scaring investors worldwide.

That said, the good news here in the U.S. is that our banks are in good shape, our nation's indebtedness is not yet out of hand, and our economy is showing steady signs of progress in 2013.

All in all, here at home we have have several good things going for us. Even the fact that the domestic economy is slow and that jobs aren't being created at a fast enough pace is not bad news for the future outlook. In fact, that slow but steady growth scenario is one big reason we can expect interest rates to remain low for at least a few more years.

And in turn low interest rates should facilitate future economic growth, investment, job creation, borrowing, housing gains and higher stock prices as well.

Thus, the good news is that we're definitely not in the position of Europe, and that's a very good thing.

Easy-Money Era a Long Game for Fed describes the current and future interest rate outlook as follows:

"The gazillion-dollar question in financial markets these days is this: When will the Federal Reserve turn to the exit ramp?

Investors, lenders and many other market participants obsess about the end of easy money and the broad implications it carries. When the Fed decides to pull back from its latest bond-buying program—$85 billion a month in Treasury and mortgage debt purchases—or when it starts raising short-term interest rates from near zero, stocks could tumble, borrowing costs jump and the economy slow.

In the run-up to the Fed's policy meeting Tuesday and Wednesday, Fed Chairman Ben Bernanke and other top officials have sought to signal that the unwinding isn't likely until the recovery is much further advanced.


A Wall Street Journal survey of 50 private economists, conducted March 8-12, shows the message is sinking in. Economists who follow the Fed, on average, expect more than another year of bond buying, more than two more years of rock-bottom short-term interest rates . . . . "It is a new era for monetary policy," said . . . a former Fed staff economist. . . .

In the PFC era—for "Pre-Financial Crisis"—the central bank managed just one short-term interest rate and expected that to be enough to meet its goals for inflation and unemployment. That rate is the federal-funds rate, which banks charge one another on overnight loans.

In the AFC era—"After Financial Crisis"—the Fed is working through a broader spectrum of interest rates. By using its bond portfolio and the messages it sends about future plans, the Fed is seeking to influence an array of long-term interest rates, mortgage rates and other borrowing costs that touch households, businesses and investors. . . .

Economists surveyed . . . said they didn't expect the Fed's balance sheet to return to normal . . . until December 2019. More than a decade after the financial crisis ended, in other words, the Fed might still be a big player in long-term bond markets, directly shaping long-term rates. . . .

By turning more dials to influence a wider array of interest rates, Fed officials could be in a better position to prevent another financial crisis. But they also could face more complicated decisions, new opportunities for error and criticisms for being more intrusive.

Critics of the Fed's policies fear the central bank will start tightening credit too late to forestall a sharp rise in inflation or a new financial bubble.

Of course, the Fed's policy is subject to change in response to myriad scenarios. Fed officials have said they will keep short-term interest rates near zero until the jobless rate drops below 6.5%, something that they don't expect to happen until 2015. If unemployment falls faster than expected, or if inflation takes off, or if new financial bubbles emerge, the Fed might decide to hit the brakes sooner than anybody is expecting and in ways that aren't now on the table.

But (economists don't) see that happening. The economists predicted the jobless rate wouldn't hit 6.5% until June 2015, and they see inflation remaining near 2% for the foreseeable future. They also said markets weren't overheating, despite a recent run of stock-market highs; on a scale of 0 to 10, they said froth in markets was about a 5.

The Fed, by the economists' estimation, could be operating in AFC mode for a long time."

Summing Up

"Don't fight the Fed" has always been good advice for individual investors to follow. It still is.

With interest rates at historic lows and the U.S. economy showing some improvement, the odds are strong that stimulative monetary policies will keep interest rates low and facilitate domestic economic growth and investment for years to come.

Assuming inflation doesn't rear its ugly head, and it won't at least for the foreseeable future, we have plenty of reasons to be optimistic about both economic growth and stock market gains in the years ahead.

And that's why I own solid blue chip stocks and no long-term bonds today. Nor do I plan to own any bonds for years to come.

It's also why Cyprus and Europe don't cause me to worry too much about our American future either.

In my view, our destiny is definitely in our hands. The game is ours to win or lose on our own.

So let's just make sure that the government knows best gang doesn't screw it all up by providing too much government "help."

That's my take.

Thanks. Bob.

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