The Federal Reserve may finally be ready to raise interest rates in December, but borrowers and savers looking for a return to normal interest rates could be in for a far longer wait.
There’s pretty good reason to think that even if the Fed finally moves, the era of what most of us regard as extraordinarily low interest rates won’t be ending. And people just may have to start asking themselves what’s normal.
This is not an interest rate forecast. If anyone really knew with confidence how to correctly call the direction of interest rates, they sure wouldn’t be writing for a newspaper.
Instead what I have is just the observation that people seem to have a hard time changing how they think our economy works or should work. Somehow they keep expecting that once a crisis passes — like the Great Recession did — things will just get back to normal.
A 10-year Treasury note that pays investors far less than 3 percent still doesn’t seem normal. Except, of course, that it just may be.
In conversations with bond market analysts and managers last week, just what is normal was a little difficult to pin down, based on long experience in the chaotic world of fixed income investing.
Still, they agreed that rates really are likely to at least start inching back up. That was solidified last week after Fed Chairwoman Janet Yellen told a congressional committee that raising interest rates in December was a “live possibility,” although she also stressed that no decision had been made.
It will mark the end of a very long cycle that goes back to the early 1980s.
That’s when 10-year Treasury notes yielded more than 15 percent, homeowners signed up for 30-year fixed-rate mortgages at interest rates of more than 18 percent and some of the borrowers most under stress, American farmers, blockaded the Federal Reserve’s headquarters on Washington’s National Mall with their tractors.
Of course, none of that seems normal now.
It was also precisely when investors should have bought bonds. Interest rates from that point kept declining. A big part of the story is that the rate of inflation declined as well, since inflation is such a big factor for interest rates.
On the way down there were lots of abnormal events, too. There was a South American debt crisis, an Asian economic crisis and even a worrisome crisis precipitated by the threatened collapse of a Connecticut hedge fund that had been set up with the help of Nobel laureates.
Then came the global credit crisis in 2008. That’s when the Federal Reserve took short-term interest rates to near zero and kept them there.
Even long after the worst passed, the Fed kept injecting money into the banking system by buying many billions of dollars of U.S. Treasury and other securities.
In the old days, before the financial crisis and the bond buying policy called quantitative easing, excess reserves were a bad thing for bankers. The reserves just sat there instead of being profitably lent to bank customers. That’s why excess bank reserves totaled less than $2 billion in August 2008.
After all that quantitative easing, excess bank reserves stand at more than $2.5 trillion.
Monetary policy watchers, and not just the critics who relish bashing the Federal Reserve, wrung their hands seeing all of this unfold.
Yet their greatest fear, ruinous inflation, didn’t materialize. For the most recent 12 months, the rate of inflation for items that exclude the more volatile categories of food and energy didn’t even hit the Fed’s target of at least 2 percent annually.
Corporate America, meanwhile, didn’t look at low rates as a once-in-a-lifetime opportunity to borrow low-cost capital and expand. By one important measure of financial leverage, the ratio of net debt to cash earnings, the average debt load for the companies in the S&P 500 declined by more than half from 2007 to 2012.
This kind of tepid investment outcome was enough to cause two respected monetary policy analysts to recently take to the Wall Street Journal to argue the Fed’s policy had actually backfired, that the easy money had somehow discouraged businesses from borrowing and investing.
After reading through this essay twice, one important take away was that it’s possible to not make sense and still remain respected. Yet the question of why this huge monetary stimulus didn’t lead to an economic boom is certainly a good one.
Economists will probably still be arguing with each other about this question years from now. But at least one observation that has come out of it so far is that the so-called natural rate of interest must have dramatically declined.
This is an old idea in economics, the natural rate of interest, and it means the general level of interest rates that results in an economy that is more or less stable. If interest rates get too high economic growth is choked off. Too low and what follows is an inflationary boom.
Just why the natural rate of interest has come down is something else economists will also want to argue about. It could be economic growth prospects really aren’t so hot, putting a damper on demand for capital.
Whatever the reason, it’s hard to imagine how the Federal Reserve’s raising its benchmark short-term interest-rate, which looks likely in December, is going to dramatically change that situation.
That’s why a move to 3 percent rate for the 10-year Treasury, trading last week at a yield of about 2.3 percent, just doesn’t seem likely anytime soon.
This is not a question just for bond traders and economic policy wonks, either.
For boomers on their way into retirement, the normal thing to do had been to switch retirement money out of riskier assets like stock mutual funds and into bonds or other interest paying accounts. Then bills in retirement get paid with the interest collected.
A rate of less than 3 percent doesn’t buy much of a lifestyle unless the savings account is awfully big, but please don’t read this as advice to go trade stocks. The normal thing to do may still be the right thing to do.
But it’s certainly worth thinking about first.