Federal reserve keeps interest rates the same

Last week the Federal Reserve, commonly known as the Fed, did not change their interest rate policy. The Fed maintained interest rates at essentially 0, which has been the policy since December 2008.

What was different about this meeting, was that there was a degree of uncertainty whether the Fed would actually start to raise rates. Clearly a change in interest rates would be significant, especially since short term rates have not changed in nearly seven years.

The reason that an increase in interest rates is being discussed is because our economy is gradually getting stronger. While the pace of growth for this economic recovery has been slower than normal, it has been fairly consistent. The national unemployment rate is near 5%, which is considered close to full employment, though labor force participation is still at a rather low level.

It should also be noted that keeping short term rates near 0 is not a normal occurrence, even though that has been the case for the past seven years. For a low inflation environment, which we are in, a more neutral policy would have rates around 2%.

What appears to be the main catalyst that prevented interest rates from rising was unsettled international events. The month of August was when China devalued their currency, and there was a significant correction in global stock markets.

Also, the Fed is somewhat concerned that inflation remains a little below their target level of 2%. Of course in our local area, most people are not overly concerned about inflation being two low. That is because housing costs represent a disproportionate share of our expenses relative to the rest of the country, and these expenses are rising significantly faster than the overall inflation rate.

There are several implications for interest rates staying low. For consumers who have loans that are variable in nature, such as a home equity loan this is clearly a benefit. In addition auto loans will remain at very low levels for people with good credit.  For those obtaining a fixed rate mortgage, the 10 year Treasury is the key variable, and longer term rates do not always move in sync with short rates. However, on balance keeping rates low should be positive for housing.

For those with savings, or money market accounts maintaining the 0 interest rate environment is clearly a negative. It must be remembered that even though inflation is relatively low people are losing purchasing power by keeping money in a savings account.

Another implication of the Federal Reserve policy on interest rates is the currency impact. Over the past year the U.S. dollar has gained strength on speculation that we would be raising interest rates shortly, thus attracting foreign money. However, when the Fed kept interest rates the same the dollar weakened, as foreigners had less incentive to purchase our financial assets.

A stronger dollar has been one factor in helping to keep our inflation rate low, as imported goods become cheaper. if our currency reverses course, or even stays relatively stable, we will likely see somewhat higher inflation going forward.

Keeping interest rates the same had a mixed effect on the stock market. Normally the stock market does well when interest rates are low. When the Fed made its announcement the stock market initially rallied, but then reversed course and closed down modestly on the day.

Because interest rates have been near 0 for so long the positive implications of this policy are starting to lose effect. In addition the inaction by the Fed just adds to the uncertainty of when interest rates will eventually be raised.

At some point the Fed will start to raise interest rates. Whether it happens late this year, or early in 2016, it will eventually occur. When the Fed makes its move, it will be modest, and rates will only increase in small increments over time.  The impact on financial markets will probably not be that significant, but consumers should realize that borrowing costs will gradually start to rise in the not too distant future.