Market Watch: Breaking Down the Fed’s Interest Rate Announcement

Will Barnaby reflects on the Fed’s surprising announcement that it would keep interest rates low longer than expected, and what this means about the Fed’s outlook for our economic recovery?

On January 25^th, the Fed announced that they would not raise the Federal Funds rate.  This in itself is not news worthy.  The real news is in the language of the statement.  The Fed announced that they intend to keep rates low through the end of 2014, which is contrary to the expectation that rates would be held down through the end of 2013.  This is a significant statement about the confidence in our economic recovery… and not, necessarily, a positive one.

The big question is what that means for you and for the economy as a whole.  There has been a lot of good news lately and the overall economy seems to be scratching its way back, even if it is slower and with greater headwinds than anyone would like.  The employment numbers are improving.  Apple announced great year end results.  GM is back on top.  C-Corps is holding more reserves than anyone cares to hear about etc, etc…  So, why the conflicting information? Why the glum outlook?

The statement lists four concerns.

1) Housing.  A topic near to many of us, housing is still the primary domestic drag on the economy.  The data is often mixed and can change from month to month, particularly when it comes to the direction that things are going to head.  The old rules of supply and demand coupled with the ability to borrow, have to become far more balanced.  Housing also has to show continued movement in the right direction and has to pick up the pace of improvement.

2) European debt crisis.  There does not appear to have to be any real actionable information about the European debt crisis, but merely a feeling of how well the negotiations are going.  One day it’s solved, the next it is an insurmountable.  We have two political parties in this country whose divisiveness over economy policy is often remarkable.  Now imagine a number of countries with their own economic policies and political parties trying to come to an agreement on policy and direction for a region, while the policy makers keep their jobs.  Not a pretty picture.

3) Unemployment numbers.  Job growth has improved, but it is still not growing fast enough.  This problem does not seem to be correcting itself quickly.

We need to replace the jobs lost in the financial crisis and the housing crash.  While much of our economic policy over the last 30 years was aimed at bolstering the stability, wealth and size of our middle class by enticing large corporations to provide decent paying manufacturing jobs, our progress has been less than ideal.  Both manufacturing and personal savings rates are not up to par.  If arriving at our goal was a trip, not only have we not arrived at our destination we’ve been missing our bus for a few decades.  Those jobs now require training that our employee pool seems to lack.

4) Slow business investments. There is a dividing line through the business community.  There is the international C-Corp business, whose reserves have swollen, and then there is everyone else, whose reserves have improved modestly.  While part of the business community has the funds to reinvest in their business, the overall economy, and/or job creation, this is also the part that is less likely to employ Americans and bring funds and tax revenue to this country.

So while there are a lot of good things going on in the economy there are still a few things holding us back.  The language of the Fed statement will likely keep the consumer rates down for a while, which is good for housing and mortgage costs.  The question is – how low and for how long?  The certainty of the policy will likely help business plan for their future investments, and will give them time to implement plans a bit further out.

However the negative or muted feel of the statement will likely cause investors to be more cautious of putting money on the line.  It will likely cause a more conservative investment trend.  Money has already moved from equities to securities and precious metals.  Though memories seem to be growing increasingly shorter in our markets the lack of enthusiasm could slow market improvements.

In sum, it appears that we are making headway, but we are still not Usain Bolt.

Photo taken by Dan Smith.

Central Coast Lending is a mortgage broker with offices in Morro Bay, San Luis Obispo, Paso Robles and Arroyo Grande.