What to Expect Next in Interest Rates

Yesterday, I wrote about how it was in the best interest of the U.S. Federal Government to keep interest rates low. The higher interest rates are, the more the government will have to spend on interest to support its ever-ballooning debt.

You may also remember a couple of months ago when the U.S. Federal Reserve said it would start its “measured” increases in interest rates. While many analysts had expected rates to rise three full percentage points by the end of 2005, this economist was somewhat more reserved. I couldn’t see rates spiking so much because the economy was and still is performing poorly.

Last week, during Greenspan’s remarks to the House of Representatives Budget Committee, it became clear that we can expect another one-quarter-point increase in the Federal Funds Rate when the Fed convenes on September 21, 2004, but further rate increases are in question.

The Fed’s “beige book” said the economy continued to expand, but “several districts indicated the pace had slowed.” Further, “household spending was reported to have softened in many parts of the nation, reflecting lackluster retail sales and some cooling in new and existing home sales.”

With these comments, the Fed has made it very clear that future rate hikes, after the expected September 21st hike, may need to be put on hold. After this month’s hike, the Federal Funds Rate will move to 1.75% from its recent 46-year low of 1%.

The action in the bond market over the past three months tells the story of an easing in interest rates hikes as well. Unfortunately, after bringing rates to their lowest level in almost half a century, the Fed was unable to stimulate the economy enough.

Last week, Greenspan also noted that the prospect of rising inflation seems to be waning despite the rise in oil prices. Of course, the Fed didn’t make mention of the dreaded “D” word: Deflation. But if you ask me, the action in the huge bond market is suggestive of a coming stop to the interest rate increases and possibly some easing down the road. The bond market action is indicative of deflation, not inflation. I’m sure the Fed is well aware of the deflation threat, but not publicly talking about it.