Monetary policy: Two words that can strike fear into the hearts and minds of bankers, brokers, investors and just about everyone involved in any financial decisions.
Each time the Federal Reserve's Open Market Committee meets, the world waits anxiously to see what the panel believes to be the path for economic growth, inflation and interest rates. Every word in the statement is parsed to see if there is any clue to what the future holds.
However, in recent months the Fed statement has been like a broken record, repeating the mantra of slow but steady recovery, inflation under control and short-term interest rates locked in at practically zero.
As a result, people who watch the pulse of the economy keep asking the question, “When will the Fed change policy?”
The Mid-year 2010 Economic Outlook from the Securities Industry and Financial Markets Association's Advisory Roundtable offered a suggestion on what could be in store.
“Expectations have shifted considerably since the December outlook, when panelists believed that the FOMC would begin raising rates in mid-to-late 2010. The current survey found that only 12 percent of respondents expected a rate hike in 2010, while over half predicted that the FOMC will begin raising rates by mid-2011 and the remainder in late 2011 or the beginning of 2010,” cites the report.
Of course, when the Fed does decide to raise interest rates, it will be the result of economic growth, which has been elusive at best. “The self-correcting adjustments by business and real estate markets and the normalization of private credit markets were again ranked as the two most important factors supporting U.S. economic growth,” said the SIFMA Advisory Roundtable.
There is little doubt that the real estate market -- both residential and commercial -- continue to be among the weakest links in the U.S. economic recovery. The recently ended tax credit program for first-time homebuyers provided a surge in activity in the first half of 2010 but it now appears that many purchases that might have occurred later this year were moved forward to seize the opportunity.
And, some suggest that any upward move in rates by the Federal Reserve would also likely lead to higher mortgage interest rates, something that would likely slow any rebound in home sales and, therefore, home prices.
That means Ben Bernanke and his colleagues will have to be very careful in changing the direction of monetary policy.
“Because of low inflation and new concerns about economic growth, the Fed appears unlikely to raise interest rates until sometime next year. Monetary officials will need evidence of consistently strong economic growth, including healthy job gains and a firming in inflation measures, before they pursue their 'exit strategy' from the current environment of near-zero interest rates,” said Lynn Reaser, chief economist at Point Loma Nazarenne University's Fermanian Business and Economic Institute.
Reaser also serves as the current president of the National Association of Business Economics.
The NABE recently said that job growth now appears to be on a steady footing with the unemployment rate, falling to 8.5 percent by the end of 2011. It also raised its estimate of full employment to 5.5 percent from the previous level of 5.0 percent.
So, what does history tell us about the future for interest rates?
“Historically, the Fed does not begin interest rate moves until about a year after the unemployment rate peaks. Assuming that unemployment peaked last fall, tightening may occur sometime toward the end of this year. However, if the unemployment rate continues to stay high, leaving a lot of labor market slack, it is likely that immediate inflationary concerns will not exist and the Fed will not be quick to move,” said the second quarterly 2010 economic discussion from the American Bankers Association.
Even chairman Bernanke himself expressed uncertainty about the course of the economy -- not to mention interest rates -- in his testimony on Thursday before the Senate Committee on Banking, Housing and Urban Affairs.
“The FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. At some point, however, the committee will need to begin to remove monetary policy accommodation to remove the buildup of inflationary pressures. When the time comes, the Federal Reserve will act to increase short-term interest rates,” said Bernanke.
There are a lot of bankers, brokers and investors who will be watching closely to see when that change in policy occurs.