The future direction of interest rates has been the subject of several recent PROFIT CONFIDENTIAL commentaries for a reason: Knowing the direction of interest rates is fundamental in planning for your borrowing needs and your investments.
If you have a mortgage or loan, you want to ensure that, in the long term, you pay the lowest rates possible. If you invest, you are likely aware that no other factor has such an impact on the value of investments than interest rates.
The consensus has been calling for a one-percentage point increase this year and about a two-percentage point increase next year in the Federal Funds Rate. My view has been somewhat different based on my belief that the U.S. economy is not doing as well as expected and that Greenspan will be reluctant to raise rates in a weak economy.
More evidence of weak economic activity surfaced last week, cementing my view on interest rates:
— In June 2004, only 112,000 new jobs were created in the U.S., well below the 250,000 new jobs expected by economists.
— 11,000 manufacturing jobs were lost in the U.S. in June after four months of small increases.
— May 2004 U.S. employment figures were revised downward from an initial report of 248,000 new jobs to a revised figure of 235,000 new jobs. I would not be surprised to see this revised once more.
— U.S. May durable orders fell by 1.6% — a surprise to economists who had expected a 1.5% increase.
— U.S. gross domestic product (GDP) for the first quarter of this year was revised down to 3.9% from 4.4%.
— U.S. June auto sales fell 2% — the worst June since 1997 despite major incentives for consumers.
Economists are calling for a Federal Funds Rate of 4% by the end of 2005, a 300% increase from the current rate of 1%. Given our weak economy, I question Greenspan taking the full action, unless inflationary pressures become unbearable.
If rates were in fact going to rise by such a degree, the stock market, which is the best leading indicator I know of, would be in a tailspin. And that’s not happening right now. I believe the stock market is telling us, yes, rates will rise, but not by that much. Seeing the Federal Funds Rate going to 2%, maybe even 3% could be a possibility, but I would question any rate increases above that unless real economic growth is delivered.