While there’s no inflation problem now, there could be one down the road.
Get Instant Access to This Article
Subscribe to Hartford Business Journal and get immediate access to all of our subscriber-only content and much more.
- Critical Hartford and Connecticut business news updated daily.
- Immediate access to all subscriber-only content on our website.
- Bi-weekly print or digital editions of our award-winning publication.
- Special bonus issues like the Hartford Book of Lists.
- Exclusive ticket prize draws for our in-person events.
Click here to purchase a paywall bypass link for this article.
The New Year starts with abnormally low interest rates. Short rates have been near zero since 2008 when the Fed slashed them to combat the Great Recession. Then the Fed started buying Treasury bonds and mortgage-backed securities in order to pull down long-term yields. More than $4 trillion in purchases have helped bring the 10-year note to a little above 2 percent.
However, interest rates are starting their inevitable climb (the Fed recently decided to raise short-term rates). While there’s no inflation problem now, there could be one down the road if the Fed waits too long. Plus, low rates are distorting financial decisions. They pump up stock prices and encourage people to take on too much risk as they “reach for yields.”
What’s ahead? The Wall Street Journal survey of economists sees fed funds rising 200 basis points (100 basis points equal one percentage point) over the next two years and long-term bond yields up about 150 basis points. This is really pretty modest. Inflation is expected to remain low. And the Fed doesn’t want to wreck the recovery. Plus, most of the world seems to be growing slowly — if at all.
Bottom line: Today’s 30-year fixed-rate mortgage of just under 4 percent will be around 5.5 percent two years from now. Bank certificates of deposit will be paying about 200 basis points more. The prime rate will be in the vicinity of 5.25 percent. We can live with these against the backdrop of a stronger economy, with more jobs and incomes and higher house prices.
Attention will soon start shifting to when the Fed will shrink that massive portfolio it acquired since 2008. Since downsizing reduces the demand for these securities, the Fed could put some additional pressure on long-term interest rates. My bet is that the Fed will just let it run off gradually as the securities mature to minimize uncertainty in the financial markets.
There are some risks to forecast:
• If Greece exits the Eurozone it will lead to chaos — a real Greek tragedy. Vultures may start hovering over Portugal and Italy. Greece will never be able to repay its debts so the only question is: Will Europe give up before or after Greece collapses?
• Middle East — who knows where this ISIS thing will lead?
• What do we do if we have another recession? We’re out of ammo. But the Wall Street Journal consensus puts odds of another recession at only 15 percent for the coming year.
• Europe — can it avoid deflation? Some are even worried about deflation in China.
Here’s what you shouldn’t worry about, at least for the next few years:
• Inflation is low and will stay low.
• Interest rates are low and will rise slowly, provided that extreme tax cuts or spending increases don’t get enacted by Congress after the election. These could explode the budget deficit.
[See what others are saying on HBJ's Economic Forecast 2016 page]
Read more
