Federal Reserve & Interest Rates

If you decided to hold off on refinancing your mortgage, you may have missed your chance.  After hitting all-time lows, mortgage rates have crept above 5% once again and many analysts feel that it will likely stay above that figure barring a Federal Reserve move to intervene once again in the mortgage securities market.

While the stock market probably won’t see a big rally this year, many investors feel that the free fall is over and that it’s time to start getting back in.  Of course that can change in a heart beat with many on Wall Street down on earnings for the most part.

That being said, we’re seeing pressure for higher yields in the market, across the board.  For the most part that all starts with Treasury yields which have also started to climb recently in anticipation for the glut in supply once the government starts selling it’s massive debt it has accumulated over the past year.

The housing market still hasn’t recovered so it’s not out of the realm of possibility that the Fed may intervene, although for now signs point against it.  The market is forward looking and while inflation is expected to remain flat in the short term, there is the expectation of higher inflationary pressure in the long run.

Commodities have also started to creep back up and depending on how global demand reacts, it will likely determine if the Fed feels if it is safe to pump more money into the system and purchase additional mortgage and Treasury securities.

The Labor Department released it’s April jobs report on Friday, which while was still a significant loss of jobs, was less than what many economists were forecasting.

Nonfarm payroll employment continued to decline in April (-539,000), and the unemployment rate rose from 8.5 to 8.9 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  Since the recession began in December 2007, 5.7 million jobs have been lost.  In April, job losses were large and widespread across nearly all major private-sector industries. Overall, private-sector employment fell by 611,000.

The country now has the highest unemployment rate since the recession of the early 80’s and employment is typically one of the last things to recover after a recession.  It is expected to hit double digits even if economic growth returns to the positive side by the end of the year, like the Federal Reserve is predicting.

The long recovery that is expected to take place will likely see slow job creation at least initially.  Manufacturers are still try to reduce inventory levels amid falling demand and it could be some time before production fully recovers.

The recently passed economic stimulus package is expected to created 2 to 3 million jobs over the over the next 3 years but that is still only half of the number of jobs that have been lost already and will likely be only a third of that number before employers starts to hire once again.

It’s going to have a serious impact on consumer spending over the next few years and this year’s stimulus payments will only give a boost for a few months at most.  Despite all the money the government has already spent over the past two years, there will likely be pressure on Congress and the administration to create additional stimulus packages in the upcoming years in order to replace all the jobs that will have been lost after the recession finally blows over.

Over the past few months we’ve seen the Federal Reserve increase it’s balance sheet activities once lowering interest rates no longer became an effective monetary policy tool, since they rates were already at zero.  Despite the trillions of dollars the Fed has poured into the money supply, they remain convinced inflation concerns remain negligible at this point in time and a big reason is because the Fed is basically acting as a substitute right now for institutional investors who are wary of even committing to short term money markets.

Most of that money has gone into seclusion in the form of the flight to quality into Treasury Securities.  Back in December, short term Treasury yields fell to zero, the first time that has ever happened.  Keep in mind that the government is also spending more money than ever and  is expected to run trillion dollar deficits for at least the next three years.

Despite what the Fed thinks, some investors are still wary of inflation with demand for 5 year Treasury Inflation Protected Securities(TIPS) causing yields to actually fall below 0% last month.  Some of this also has to do with the fact that non-TIPS securities of similar maturity are also trading at record highs, so even the most skeptical investor does not see long term inflation much higher than 2% over the next five years.

Now most people don’t think this situation will last too long, how can it?  What we are seeing is a lot of people hiding their money away waiting for the market to hit bottom but when it does many people think that money will come back to the market fast seeking higher returns.

Even after the institutional money starts flowing back, the Fed may not necessarily slow down the pace of their balance sheet activities.  There is a belief held by some that we may well see the Fed actually encourage a slightly higher rate of inflation than normal in a couple of years down the road.

Most predictions have the U.S. economy contracting between 4% and 5% this year and possibly more if the recession continues to drag on.  Therefore we may see the Fed continue to increase the money supply at it’s current levels in order to jump start the economy once the recession ends.