Party Over on Cheap Debt

The Federal Reserve raised the federal funds rate from 0.5 to 0.75 percent.  That means the party might be over on cheap interest rates, especially mortgages.  Yet according to the Wall Street Journal, markets do not always follow the Federal Funds rate as other market factors come into play:

From 2004 to 2006, when the Fed raised its benchmark short-term rate 4.25 percentage points, yields on 10-year U.S. Treasury notes, corporate bonds and mortgage rates barely budged because of strong global appetite for U.S. securities.

No surprise many banks issuing credit cards always announced their rate increases.  Now one can expect to pay $25 more per year for every $1000 of debt carried.  But people, don't carry credit card debt unless you have a 0% introductory rate.  Auto loans aren't that impacted either, $25,000, 6 year loan means $36 more in interest charges per year.

On mortgages it is more unclear.  According to CNBC, fixed mortgages are tied to U.S. Treasuries and thus more safe from Federal Fund Rates shock increases, but anyone with an adjustable rate mortgage should consider refinancing.  Home equity loans also are impacted and their rates increase immediately, unlike adjustable rate mortgages.

According to USA Today, the rising fixed mortgage rate from 3.47% to 4.13% on $200,000 is already costing people $75 more a month.  These kind of increases can be deadly to the monthly budget for most working folk, yet home prices have been soaring as of late and increasing financing costs should put a damper on overall home prices increases.

Of course the interest on the national debt with now rise.  Schwab has a good summary on why that is:

So how would higher interest rates affect all this? To start, higher rates would mean the federal government would have to pay more interest to Treasury security holders, and the resulting higher interest costs would add to the deficit and accumulated debt.

The CBO assumes the average interest rate the government pays on debt held by the public will increase from 1.7% in 2015 to 3.5% by 2026. It also projects a sharp rise in interest rates, with the average rate on three-month Treasury bills rising from 0.5% in 2016 to 3.2% a decade later. It sees the average rate on 10-year Treasuries rising from 2.6% to 4.1%.

But that’s not the only cost. When the Fed makes a profit on its Treasury holdings, it sends much of it back to the Treasury. Such profits have totaled hundreds of billions of dollars over the past decade. However, rising interest rates could push down the value of the Fed’s holdings, as bond prices fall when rates rise. That could mean Fed remittances to the Treasury will shrink.

The combination of rising interest rates and declining remittances from the Fed could help push overall interest costs from $223 billion in 2015 to $839 billion in 2026. Relative to the size of the economy, that would increase interest costs from 1.3% of GDP to 3% of GDP over the next decade.

In terms of future rate increases, the Fed seemed to be more focusing in on inflation than other factors of the past.  From the FOMC press release:

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The magic number is 2% inflation and the focus of the Fed is clearly laser like on this figure.

Subject Meta: 

Forum Categories: 

cheap debt

Certainly the era of cheap and easy debt fueled bubbles - tech, mortgage as well as encourages leveraging M&A and stock buybacks inflating the stock market and executive pay. It also saddles consumers and students with debt that may never be fully repaid

cheap interest has also been a disincentive to save and bad news for retirees on fixed incomes. Lack of healthy savings contributed to the slow recovery as well

inflation bad news for retirees

Although now most things adjust for inflation, they often don't adjust enough. We've had years of low inflation and increasing inflation hurts fixed income, seniors.

Inflation bad news for everyone

Twenty years ago the Boskin Commission essentially removed inflation from the calculation of inflation. This "calculated" inflation value is not only the basis for COLAs for retirees and workers both Public and Private it is also used to adjust GDP calculations. Inflation is factored out of the GDP calculation thus understating inflation results in an over statement of GDP. So if you think prices are going up faster than 0.23% per year, the economy is growing slower than 2.7% per year and you've been falling behind for twenty years you're right. Now as for the birth death model and seasonal adjustments to the employment numbers............................