Higher Interest Rates Closer Than

The Bank of Canada has become the first of the G7 countries to raise interest rates since the global recession began. Today, I will tell you why the U.S. is not far behind in making the same move.Surveys by Bloomberg indicate that the U.S. Federal Reserve will start raising interest rates in the fourth quarter of this year, while the European Central Bank will start raising interest rates in the first quarter of 2011. I disagree with these opinions and expect interest rates to rise sooner.
Dennis Lockhart, the head of the Atlanta Fed, and Thomas Hoenig, the president of the Kansas City Federal Reserve, are both calling for higher interest rates. Hoenig has dissented at the last three Fed meetings, calling for interest rates to move up now. Other economists are coming out and suggesting that interest rates should start moving back up. The pressure — the movement — for higher rates is building.I believe there are two major arguments for the Fed to keep interest rates so artificially low. The first is to keep housing alive, while the second is to create job growth.Sure, the housing market is still very fragile, but it is showing signs of life. However, housing is also big-time bust. If we look back, it was the low-interest-rate policy of the Fed of 2003 and 2004 that eventually led to the housing bust.Yes, higher interest rates will delay the housing recovery, but the real problem with housing is not interest rates. The problem with the U.S. housing market recovery is the huge inventory of unsold homes and the millions of Americans whose property values are lower than their mortgages.

As for unemployment, economists were expecting the biggest jump in U.S. non-farm payroll in 27 years to be announced today, with close to 550,000 jobs created. They didn’t get it. Only 431,000 jobs created in May 2010 — but still five months of improving job reports. Keeping interest rates artificially low is not having the desired effect on jump-starting employment. (The May employment job growth figures were very distorted because of the government hiring of
temporary census employees.)

If we continue to keep interest rates low, what ammunition will the Fed have to help the economy on its next contraction phase? Monetary policy is supposed to change as the economy expands and contracts. We cannot help the next down leg of the economy by
reducing interest rates if rates remain at zero.

Finally, no one is talking about inflation. I’ve never seen a time in history when interest rates that are low were not followed by inflation in the U.S. Why would this time be different?

Keeping interest rates at artificially low levels cannot last forever. In fact, the environment of interest rates that are artificially low we are in today could end up hurting us more than helping us. Even if the Federal Funds Rate moves to one percent, interest rates would still be historically low.

At the minimum, the Fed should raise rates to one percent by the end of this year. Regardless, if our national debt keeps rising so quickly, the eventual strain on the value of the U.S. dollar will force interest rates up on their own.

Where the Market Stands:

The Dow Jones Industrial Average starts this morning down 1.7% for 2010. While the hardcore, old-time market watchers are calling for stocks to go down from here, I see too many people still concerned that the economy will take a double-dip. Bear markets do not move lower when people are concerned about the stock market and the economy. The bear will rear its ugly head again at the most unlikely time.

Initial public offerings are still far and few between, which makes me believe that the individual investor has yet to return to the stock market. I still see more up-leg left in this bear market rally.

What He Said:

“I’m getting very worried about the state of the U.S. housing market and its ramifications on the economy. The U.S. could be headed for its first outright annual decline in home prices on record, adjusted for inflation. And I really believe this could be a catastrophe for the U.S.
economy.” Michael Lombardi in PROFIT CONFIDENTIAL, August 2, 2006. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.