The following is a guest post from Richard Barrington, the financial spokesperson of MoneyRates, a freelance writer and novelist who previously spent over twenty years as an investment industry executive.
Sometimes it seems as though bank customers cannot catch a break. Just as the national savings rate reached a decade-long high this year, the interest rates banks offer on those savings shrunk to microscopic levels. However, if you've been disappointed by blah bank rates, hang on. There are at least five reasons to expect those rates to take a turn for the better:
1. The end of the recession. Classically, an economic expansion creates more demand for capital, and thus can push interest rates higher. With some optimistic signs for the U.S. economy, it may be that the end of the long recession is in sight. Besides the cyclical boost to interest rates that could accompany with the end of the recession, a scaling back of government intervention to keep interest rates low would allow them to rise to more natural levels.
2. Inflation. The past year has seen deflation on a scale not experienced since the early 1950s. Interest rates normally offer a small premium over inflation, so a return of inflation would mean a move up in interest rates. Of course, depositors don't really benefit when higher rates result from higher inflation, but this would make it all the more important for depositors to move with the market.
3. A rebound in housing. Recent months have seen a mild recovery in housing prices. If housing demand mounts a more sustained recovery, it will be another factor creating demand for capital, and thus the likelihood of higher interest rates.
4. The threat of protectionism. Recently-announced tariffs on Chinese tires will not by themselves contribute much to inflation, but protectionist measures have a way of escalating. This is another factor that could push prices, and eventually interest rates, higher.
5. History. Obviously, history itself won't compel interest rates higher, but it is a useful guide to what people should expect in the normal course of events. Historically, inflation has tended to run between 3% to 4%. So, it wouldn't take extraordinary inflation, but merely a return to normal to more than wipe out today's interest rates.
The possibility of higher interest rates should do more than give you reason to hope; it should also influence your deposit account choices. It may be wise to keep deposits flexible in savings accounts whose rates will adjust upward without delay, rather than locking yourself into CDs that may keep your interest rate down after market rates have headed upward.
Who cares if rates go higher in tandem with inflation. OK, maybe stock owners do :-)
That said, if the FED doesn't keep rates low, the government will have to pay humongous amounts of interest on its debt. That means either higher taxes (as in my country, Belgium) or pressure on the FED to keep rates low (but something tells me they can't keep doing that forever). So, yes, there's going to be large inflation some day, but everyone who remembers/knows about history should already know that.
Posted by: Concojones | October 29, 2009 at 08:03 AM
I think this entry should be renamed as, "What to look for in case of rebound."
These factors would be true... if the economy is indeed rebounding. However, IF people like Bill Gross of PIMCO for example, is correct in his November 2009 letter, then the stock market is still greatly over-valued and a rebound is not within the near horizon.
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Midnight+Candles+Gross+November.htm
Now, don't get me wrong. I'm a bull a heart who would benefit greatly were the market to rebound soon (all of my investments are long). However, as far as I can tell right now, we are still experiencing deflationary pressures, which means the Fed interest rates will continue to be low into the foreseeable future, the current housing rebound is caused by value investors and fence-sitters who were enticed by the government credit and therefore is probably temporary, and I think it's way too early to say that there will be an escalation in tariff wars and even if there is one, in this case, I highly doubt it would force the interest rate hand.
I'm not trying to rain on anyone's parade here. I'm just saying this is unrealistically optimistic (though I would love to be wrong here). Contrary to Hollywood movies and anecdotal evidence, unrealistic expectations is a great way to lose money, not make them.
Well, the GDP report is coming out... tomorrow I believe. Here's to hoping that it will signal the first sign of a true, fundamental rebound. Anything before that would be purely speculative. Even a positive report here would be tenative, but would be welcomed just the same.
Posted by: Eugene Krabs | October 29, 2009 at 08:50 AM
Edit: Oops! The report was today, released just an hour ago! Intraday sentiment is upbeat. Sweet.
Posted by: Eugene Krabs | October 29, 2009 at 09:30 AM
I think we are headed for a Japan redux, meaning rates are forced to stay low as long as there is an appetite for treasuries.
As long as wages keep going down I don't think rates will go up and inflation is a concern. Will keep watching and seeing if there is any changes on this front. Still more shoes to drop (city & state layoffs so they can meet budgets)
-Mike
Posted by: Mike Hunt | October 29, 2009 at 11:13 AM
Interest rates will rise and inflation will start when the demand for goods outstrips the supply of goods.
Currently there are far too many workers unemployed, underemployed, or that have stopped looking for work.
People are still very worried about losing their jobs, homes and healthcare and are in a saving, not a spending mood. The recession is no doubt technically over but getting back to normal is still a long way off. Without Producers earning money it's hard to get Consumers that are spending money.
Last night we visited a small but highly acclaimed and very popular nearby Sushi restaurant that we have gone to every two weeks for several years. It was the emptiest we have ever seen it. Instead of people waiting outside there were about half a dozen customers inside. The restaurant had more workers than it did customers, and the workers were just standing around. A year ago they added a second room to accomodate the demand. They have now gone from being a big moneymaker to barely breaking even and this is in the heart of Silicon Valley - usually the restaurant was full of young, happy, starry eyed couples of many different ethnicities excitedly talking shop. For the last half dozen visits we have seen a steady decline in patronage - that doesn't look like a recovery to me. The same holds true at two other restaurants we visit regularly - one excellent Mexican restaurant is now so dead we have stopped going there. These are all reasonably priced restaurants or we wouldn't even be there.
Posted by: Old Limey | October 29, 2009 at 11:28 AM
Nope! The output gap is still too large for us to see any real inflation. I bet we won't break 10% inflation in our entire careers.
Everything is under control in inflation land!
Posted by: Financial Samurai | October 30, 2009 at 01:22 AM
You guys are all talking about the fundamentals, which are definitely deflationary in the short and medium term. My concern however is monetary: the extra money in the system ('printed') will push prices as soon as the economy picks up again (not any day soon IMO). Or possibly earlier, depending on how much is printed. Two parameters define the 'apparent' amount of volume in the system = the base amount (which has ballooned) times velocity (currently down but for how long?).
Posted by: Concojones | October 30, 2009 at 07:36 AM
Concojones, the Fed is taking great pains to deliberately increase the money supply in order to combat deflationary pressures. Let me say again: The short-term inflation is artificially-created.
It would not take effort on their part to decrease it at this point.
Hyperinflation is always a problem, but right now, I think that's more of a distant concern than I think many people give it credit for.
Posted by: Eugene Krabs | October 30, 2009 at 08:47 AM
@Eugene: The problem as I see it is that there is no way they can 'call back' the newly printed money when inflationary pressures show up (from energy & commodities demand by developing countries), except by raising rates massively -- but think what that would do to the federal budget.
So the question is:
1. how much debt can the gov't take on while still being able to handle high rates?
2. what's going to happen to banks' required reserve ratios?
The latter matters since higher reserves leave less money to loan out & circulate. I read here [http://www.zerohedge.com/article/end-end-recession] that at this time, current higher reserves more than cancel out the FED's money printing. But those reserves will go down again unless regulations change.
Posted by: Concojones | October 30, 2009 at 09:54 AM
Little but side a part from the above discussion I want to see the above discussed topic i.e increase in interest from different angle. When banks did provide the sub-mortgage facility to people where the interest in the scheme was very low or no interest on loan, sacrificed their profits. But due to crash in the market they even unable to recover the cost and suffered from big losses. Government do provide help to these institutes but should not put all the burden on the shoulder of government, it must be share with other industries. . .
Posted by: Clara James | October 30, 2009 at 10:53 AM
Concojones, with all due respect, but you can "call back" the money supply. Actively, they can sell back all the bond and treasury assets they've seized during this recession. Passively, they can simply stop the printing presses, and let the money shrink on its on. (Banks regularly ship them old and worn currency that is to be taken out of distribution.)
As for the reserve issue... the link is gone so I can't comment on the article. But suffice to say, the regulations can be changed back.
Posted by: Eugene Krabs | October 30, 2009 at 12:08 PM
Note about the link I posted: it works if you leave out the last bracket. BTW it's a TERRRIFIC summary on the state of the economy. I've been following the authors' blog for a while and while their target audience is clearly not laymen, well, I can still appreciate it.
@Eugene: selling the treasuries would have a serious effect on interest rates (after all, buying had a serious effect too), and they can't call back the money supply: you can't just confiscate and destroy someone's savings.
Posted by: Concojones | October 31, 2009 at 07:49 PM
Ah, I really should have checked the URL and caught that bracket. And yes, thank you for sharing that presentation. It is indeed very informative.
However, I've never argued that the economy is getting better. If anything else, I too am bearish and believe we may be facing a double dip.
The specific issue we are having here is whether or not the Federal Reserve can "call back" the excess money supply they've inject.
The slide show does not say that they can not. Specifically, as stated in slide 68, "The question then becomes how much more can the Fed grow its Balance Sheet liabilities before foreign countries completely shut down the spigot on purchasing U.S. Securities?"
Nevertheless, from a technical standpoint, it is indeed quite possible for the Fed to decrease their money supply. Also, please understand that the prospects of deflation actually benefits treasury holders! It's just not good for stimulating the domestic economy.
However, I would agree that inflating money supply this high is not without its consequences. And to be clear, I've never said that it would be painless. Like chemo for cancer, the procedure in itself is risky and destructive, but our economy is a very sick patient at this time, and unfortunately, this is a necessary move on the Fed's part. The alternative would have been a near-guaranteed, runaway deflation that could turn this recession into a depression....
So, for all our sake, let's hope that the economy's condition stabilizes before the money supply medication collapses.
Posted by: Eugene Krabs | October 31, 2009 at 11:45 PM
Oh, and one more clarification. The Fed injected liquidity by buying a lot of their own Treasuries and MBS from holders, as stated in that same presentation you linked to.
By mandate, they swapped bonds for cash.
If they want to decrease the money supply, they would sell it back out.
By mandate, they would swap cash for bonds.
Market pressures aside, the basic value is not destroyed, merely exchanged.
Once they get the cash back, they would simply not use it, thereby decreasing the money supply.
Does that make sense?
Posted by: Eugene Krabs | October 31, 2009 at 11:50 PM
Eugene,
Thanks for your efforts. It's quite a challenge discuss a complicated topic like this on a blog, so perhaps we shouldn't take this too far.
That said, where did the cash used to buy Treasuries come from? They created it out of thin air. Hence my concern.
Posted by: Concojones | November 01, 2009 at 05:03 AM