SIGN UP for JEC EMAILS

Email Signup
Related Image

The financial market volatility that followed the Fed’s December rate hike led most market watchers to conclude that the projected four increases incorporated in the Fed’s December “dot plots” would be delayed. After assessing the comparative strength of the U.S. economy and improved employment statistics, most Fed-watching economists expect no rate rise before June. Yesterday’s FOMC press release announced no increase in interest rates; the accompanying “dot plot” projections echoed market expectations, anticipating just two Fed rate increases this year. As FOMC members revised their GDP forecasts slightly lower, this implies that they determined more easing was justified, despite falling unemployment:

March Projection

2016

2017

2018

Previous Dec.  Projection

2015

2016

2017

2018

Change in Real GDP

2.2%

2.1%

2.0%

Change in Real GDP

2.1%

2.4%

2.2%

2.0%

Unemployment Rate

4.7%

4.6%

4.5%

Unemployment Rate

5.0%

4.7%

4.7%

4.7%

PCE Inflation

1.2%

1.9%

2.0%

PCE Inflation

0.4%

1.6%

1.9%

2.0%

Core PCE Inflation

1.6%

1.8%

2.0%

Core PCE Inflation

1.3%

1.6%

1.9%

2.0%

Fed Funds Rate

0.9%

1.9%

3.0%

Fed Funds Rate

0.4%

1.4%

2.4%

3.3%

Note: Median projection; Source: Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents

One FOMC member, Kansas City Fed Governor Esther George, dissented, advocating faster rate increases.

 

Context

The U.S. recovery continues, slow and steady.

 

EU Impact?

While the Fed embarks on a schedule of interest rate increases, the European Central Bank is following in the steps of the Bank of Japan, implementing a Negative Interest Rate Program (NIRP). Other central banks are undertaking a high-risk zero interest rate experiment to encourage bank lending that provides economic stimulus in countries that have little or no growth and face risk of deflation. The Fed notes that it will continue to monitor the global situation.

 

The Bigger Picture

The stock market volatility seen since the Fed’s December interest rate hike has been particularly hard on retirees, who had moved investments from bonds and savings accounts to stocks because low interest rates could not provide adequate income. They have seen stocks lose 20%, then climb back to December levels; however, these value swings do not suit investors counting on income to pay retirement bills. Some advisors argue that the Fed’s low interest policy is making long-term changes to retirement planning.

There is still plenty of speculation as to how the Fed plans to deleverage the assets it has accrued over the course of the recession and into the recovery. As of March 10, the Federal Reserve balance sheet reported total assets of $4.5 trillion, showing no material decrease.

 

 

 

Asset reduction may be a long time away. Today’s press release affirmed that there would be no reduction in portfolio assets until interest rate normalization is “well under way”; since their own projections see only gradual increases this year, the underlying message is that the portfolio is not shrinking.

 

Debt Impact

Significantly, a rise in rates brings with it higher service payments on the gross federal debt, which currently tops $19 trillion. In the latest Budget and Economic Outlook: 2016 to 2026 (p. 178), the Congressional Budget Office (CBO) expects net interest payments on government debt to double their share of the federal budget, rising from 1.4% of GDP in 2016 to 3.0% in 2026. In fact, over the decade these interest payments are expected to grow to be the third largest spending program, exceeding spending on national defense. Over the same time period, publicly-held debt is projected to climb by 70%, rising to 86% of GDP by 2026.

 

Alternatively, as CBO noted in its January report, if interest rates on all types of Treasury securities were one percentage point higher each year through 2026 than projected, and all other economic conditions remain equal, the projected increment of deficit increase over the decade would amount to $16 billion in 2016, $269 billion in 2026, and total more than $1.6 trillion over ten years:

 

 

Federal Debt Interest Costs

 

2016

 

2017

 

2021

 

2026

2017-2021

2017-2026

Higher deficit if rates rise 1 percentage point above projections per year (billions of dollars)

16

45

143

269

470

1,622

 

Related Files