My Bold Prediction on Interest Rates

Yesterday, breaking a two-year tradition, the U.S. Federal Reserve Open Market Committee met and decided not to raise interest rates in America. Yesterday’s move marks the end of the Fed’s longest string of interest rate increases without pause in 12 years.

So, for now, the overnight lending rate between banks will remain at the highest level since March 2001. And while interest rate futures point to a 50/50 change the Fed will raise rates one more time before the end of 2006, my guess is that the Fed is finished tightening.

Sure, some analysts are claiming the Fed will have to raise interest rates again by the end of the year if inflation spikes. Sure, the Fed itself said “some inflation risks remain” in its statement yesterday. But the bottom line is the U.S. economy, especially housing, is slowing too quickly.

In fact, and I’ll go on record today saying this, I wouldn’t be surprised that after standing pat for the next meeting or two, the Fed might actually need to lower rates again. It’s just like Pimco’s big boss, Bill Gross, said yesterday: The future of interest rates in the U.S. will depend on the housing market. And if my contacts in the real estate market are correct, the U.S. housing market is softening quicker than American consumers can understand.

One more thing: The Federal Reserve has it all wrong. It’s not inflation that the Fed should be worried about, it’s deflation. Aside from crude oil, nothing else is really moving up in price. The action in the housing market and stock market is deflationary. Prices for goods, courtesy of China Inc., are actually falling. But don’t be fooled, the Federal Reserve is not oblivious to inflation. By not raising interest rates yesterday they clearly gave the message that the economy takes precedence over inflation (maybe because there is none!).

So, how does all this affect investors like you and me? As I said last month (see Profit Confidential issue of July 24, 2006, “Bonds Could Now Be a Buy”), bonds are the place to be. If you have money you can loan out as quality first or second mortgages, this may be the highest rate you’ll be able to get for some time to come. Alternatively, if you need to borrow, wait. It will be cheaper for you to borrow next year.