Friday, April 26, 2013

Interest Rates Likely to Remain Low for Another Decade ... A Muddle Through Economy is in Our Past, Present and our Future, Too

Many people today with savings and money to invest are wondering what to do about low interest rates.

The first thing to realize is that in a period of stable to increasing interest rates, fixed income instruments of substantial duration are a bad deal for savers and investors. In other words, don't buy 20 year bonds or even bond funds if you think interest rates are likely to rise during the period of the bond's duration. And that's exactly what's likely to take place during the next several years.

Bonds are a bad deal in a period of rising interest rates because of two simple mathematical facts: (1) bonds owned become worth less than their face value as interest rates rise; and (2) the coupon or yield on the bonds owned becomes less than current interest rates on bonds of similar duration as interest rates rise.

Thus, all things considered, parking your money in cash or money market funds beats buying bonds or bond funds in a rising interest rate environment. But since cash deposits and money market funds pay virtually nothing today, what's a saver to do?

It looks like we just need to "get used to it," with "it" being many years ahead of slow growth and fighting off deflation and/or inflation here in the U.S. and around the world as well. We need to treat blue chip dividend paying stocks as the fixed income part of our long term investing portfolio for at least the next several years.

In the U.S. as well as much of the rest of the world, we're currently in debt up to our eyeballs, and government spending has grown bigger than ever. The failed policies of a "progressive" welfare state are becoming more evident with each passing day, and the government knows best gang is not taking the necessary actions to get solid private sector driven economic growth on an upswing. As a result, we're going to be "muddling through" the financial mess we're in for at least several more years.

Yes, this time really is different, and the free lunches are over. It's time to clean up our act, and the sooner we start, the quicker we'll finish.

In the meantime, we can expect a prolonged period of anemic economic growth, high unemployment and low interest rates accompanied by low inflation. At least that's the way I see things developing.

So does a Federal Reserve official in Very Low Rates Could Persist for a Decade:

"A Federal Reserve official said . . . interest rates are likely to stay very low for years to come, which raised the prospect that chronic financial instability risks will dog the economy for a long time.

Federal Reserve Bank of Minneapolis President Narayana Kocherlaktoa said, “For many years to come, the FOMC will have to maintain low real interest rates to achieve its congressionally mandated goals. Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,”. . .

Mr. Kocherlakota’s comments came from the text of a speech that was to be presented at a conference held in New York by the Levy Economics Institute of Bard College. . . .

In his speech, the central banker said that the low interest rate world that could persist for “possibly the next five to 10 years” is in part the result of Fed actions over the course of the financial crisis and its aftermath. But the central banker said that other forces are also conspiring to keep rates very low.
The three that are most important beyond Fed policy are tighter credit availability, increased worry about economic risk and uncertainty surrounding the outlook for U.S. government finance, he said.

These factors are causing investors, households, and firms to keep their money where it is safest, and it is also causing them to save more. At the same time, those who need better yields will go into riskier assets, creating the risk prices for those markets could go haywire, the official explained.

In as much as Fed policy has helped create the low returns savers are wounded by, so too have market forces, Mr. Kocherlakota said.

“I often hear that the FOMC has created a low interest rate environment that is harmful for savers and others,” he said. “That seems about as compelling as blaming me for creating winter in Minnesota by putting on my long johns,” Mr. Kocherlakota said.

The official said in his speech he expects unemployment to fall “only slowly,” and he said “inflation pressures are muted.”"

Summing Up

The U.S. economy is in slow growth mode and will be for a very long time.

This signals that short term interest rates are likely to remain at historic lows as the Fed attempts to get our economy moving again and stave off deflation.

In the meantime, the risk is that inflation will rear its ugly head before the economy is able to escape stall speed and fly on its own.

Let's hope that the politicians don't do anything else to give We the People cause to have even less confidence in the government knows best gang than we already have.

We the People need to have confidence in the future, and we need less government intrusion at the same time.

It's going to be a muddle through economy as far as the eye can see, and the "good old days" are a long way off. But they'll be back.

That's for sure.

Thanks. Bob.

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