Federal Reserve & Interest Rates

The Open Market Committee once again agreed to keep interest rates unchanged at between 0% and .25% this week.  As long as inflation concerns remain muted they would prefer to keep rates as low as possible in order to stimulate a faster recovery.

Although last quarter’s GDP numbers were still negative, they were better than what many economist had forecast and there are increasing signs that economic growth will turn positive by year’s end.  While that may be the case, it should be pointed out that with consumers unable to do so, it has fallen to the federal government to try to spend it’s way out of the current recession.

It will still be some time before consumers will feel like there’s an actual recovery with unemployment expected to climb up to the end of the year.  Whether or not the Fed will be able to keep rates at their current level until there is actual job growth remains the big question.

Much of this will depend on how the price of oil reacts as economic conditions start to improve, if speculators start pushing the price up once again, like they did a year ago, it could quickly derail any chance of a timely recovery.   That would also likely lead to a rise in commodity prices in general but at this point the demand figures would seem to preclude that.

If rates can remain low for an extended period of time, it would also go a long way in helping out the housing markets, which has seen increased buying activity in recent months.  However, high foreclosure rates remains a problem for the banking system, clogging their balance sheets with toxic assets.

So even if GDP does start to rise once again in the next couple of quarters, it doesn’t mean by any stretch of the imagination that we are out of the woods yet.

Many people are holding out hope that the end of the recession is in sight but even if that’s the case, the banking system will still be in a fragile state for quite some time.  As long as the housing market remains deflated, banks are going to have those toxic assets hanging over their heads.

The Treasury Department has done a reasonable job so far of quarantining the toxic assets that have plagued the banking system over the past 2 years, but there are increasing worries that more money will be needed.  The government has already pumped in trillions of dollars into the financial system to keep it from collapse and with Congress focused on healthcare reform, which is expected to cost another trillion, getting anymore money from them may be exceedingly difficult.

The big banks probably don’t have much to worry about, as long as they pose a systemic risk on the rest of the economy, I’m sure Congress will find them the money somewhere.  However, smaller banks on the other hand are an entirely different story.

Need a job?  Try applying for one at the FDIC in the next few years, they are going to have their hands full.  Hundreds of the smaller regional banks are expected to fail in the next few years unless remarkably for some unfathomable reason the housing market shows a full recovery in the next year or so.

Some experts are claiming that the housing market is finally bottoming out, but much of the increased sales activity recently has been from distressed properties and the supply of those keeps growing as foreclosure rates are still high.  Much of what happens to the housing market next will depend on whether or not the Fed can keep mortgage rates low for an extended period of time.

Fannie Mae and Freddie Mac are also turning to the Treasury for money as essentially they have been given a mandate from the government to try to guarantee as many mortgages as possible and are losing billions trying to do so in this type of economic climate.

While the economy is still embroiled in a recession, there was some positive news today when the Commerce Department released it’s June figures on new home sales.  However while purchase activity has risen the last few months, prices still remain depressed.

The Commerce Department said Monday that sales rose 11 percent in June to a seasonally adjusted annual rate of 384,000, from an upwardly revised May rate of 346,000.

It was the strongest sales pace since November 2008 and exceeded the forecasts of economists surveyed by Thomson Reuters, who expected a pace of 360,000 units. The last time sales rose so dramatically was in December 2000.

Much of the activity can probably be attributed to the Fed’s actions in the mortgage securities market which helped lower rates to all time lows a few months back but have risen somewhat since then.  Some prospective buyers may also have been prompted to act now on the fear mortgage rates will climb even further.

The financial system is still shaky but there is some credit available to those with good credit scores.  Foreclosures remain high and with unemployment expected to climb up to the end of the year, it is still a cause for concern and blunts some of the optimism from today’s figures.

So while this shouldn’t be taken as a sign of an impending recovery, most analysts agree that the pace of decline has definitely moderated and the housing market may finally be hitting bottom.  Prices won’t recover overnight and it’s going to take a long recovery period like the rest of the economy.