Federal Reserve & Interest Rates

Although we’ve already seen the U.S. government pump trillions into the financial system to prevent it from collapsing, it is by no means out of danger.  Unfortunately, financial markets will most likely be in a precarious position for many years to come.

Investors have already shown some concern over the long term implications of the government’s massive debt load and in the past month yields on 10 year Treasury Securities have started to rise.  Despite the fact that global demand is weak and is expected to remain that way for some time, we have also seen commodities markets start to creep up as well.

Inflation concerns will likely hound the U.S. financial market for years to come.  It can’t hide from the fact that Treasury yields will most likely rise in order for the U.S. to fund it’s financial recovery plan.

This will have a spillover effect on consumer interest rates and will affect bond markets for years to come.  The primary weapon to fight inflation is to raise interest rates but while that may keep inflation in check, it also serves as a severe handicap to economic growth.

There are no free lunches, so while the government’s massive intervention may have kept it from collapse in the short term, that same intervention will most likely keep it in a weakened state for quite some time.  For now the dollar has kept it’s place as a reserve currency for the rest of the world but how long that will be the case remains to be seen.

The next few years will be very important, the severe debt load of the U.S. government was already a problem before the recent massive increase and will have to be dealt with sooner rather than later.  While technically the funds the government used to save the financial system were loans and are expected to be paid back, they face a significant risk of losses due to defaults.

A number of federal agencies with the Federal Reserve and the Treasury at the forefront, will face a difficult balancing act over the next few years in order to maintain the stability of inflation and interest rates and it’s overall effect on economic growth and the financial system.

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.

Don’t look now but mortgage rates are starting to creep back up after reaching an all time low after the Federal Reserve announced it would enter the market for mortgages securities a few months back.  The thing is, with the U.S. government set to sell unprecedented amounts of debt, many investors are concerned about the long term impacts of inflation.

Over the next two to three years, inflation is expected to remain fairly flat, however, yields on 10 year notes have climbed recently which has caused a steepening of the yield curve.  The Fed has pretty much kept short term borrowing cost down by being an active participant in the Treasuries’ market but everyone knows that isn’t going to last forever.

With this year’s deficit nearing the two trillion mark already, there are grave concerns among investors on what happens to rates once the Fed finally turns off the spigot when the economy starts to improve.  Many see the Fed raising rates at a fairly quick pace once that happens, in order to deal with the repercussions all that government debt will have on inflation.

Look, in a span of two to three years, the government will have increased the national debt by about a third of it’s total before this whole mess started.  If anyone thinks that won’t have long term repercussions on our economy, you’re kidding yourselves.

All you have to do is look at is the current state of Medicare and Social Security to see what the likely outcome will be.  The government will leave it as a problem for a later generation to deal with.