My friends at JVM Lending wrote an interesting blog recently, and I wanted to share a summary, plus my input on the topic: “why the Fed can probably never raise interest rates.” Read on:
The Fed Funds Rate is a rate that banks charge each other to borrow “reserves” overnight, which is currently at 0-0.25%. Paul Volcker was a Fed Chairman in the late 1970s and early 1980s who sent the U.S. into a massive recession by raising the Fed Funds Rate to 20%.
The result of Volcker’s actions were a horrible recession, a crashed economy, and 11% unemployment. To recover, it took enormous political will – the likes of which we are in short supply of nowadays (for many reasons).
Last week, the Fed talked about the possibility of raising rates almost two years from now. Stocks tanked and interest rates shot up. Markets reacted negatively because even the mere mention of higher rates down the road causes a reaction. Investors know that our economy can’t afford higher rates.
Here’s the thing: the Fed likely can’t afford to raise the rates. Our total federal debt is about $28 trillion and growing, while State and Municipal debt is approaching $4 trillion. The interest paid by the federal government for its debt this year will be just under $400 billion, with government debt rates around 2%.
So, if rates returned to even 1990s levels (6-8%), interest owed would triple or quadruple and quickly bankrupt the government. Even more concerning, potentially, is corporate debt. There is $11 trillion in corporate debt in the U.S. and many of those corporations could not begin to service their debt if rates went up. They depend entirely upon cheap capital and bailouts.
In terms of real estate, existing mortgages do not depend on low rates. They are long-term and fixed. However, housing itself represents a huge chunk (almost 18%) of the economy, and that sector is now dependent on super-low rates, too. Basically, the entire economy is addicted to low rates and the Fed knows it.
Several pundits expect the Fed to find excuses as to why 2023 is not a good time to raise rates and kick the can down the road yet again. So, we will either see a continuation of a Japan-like situation for a very long time with continued low rates, slow growth, and massive government intervention…or inflation will set in and the Fed will lose control of rates, as investors simply demand higher yields.
Either way, I would not expect the Fed to actually raise rates itself in 2023.
KRISTIN’S TAKE: Nobody has a crystal ball, and if rates do start to edge up, it would take some time for them to get into the 5%+ range. We are also seeing a bit of a reprieve on the buying frenzy. More houses are having price reductions, not as many multiple offers, etc. I am just not sure if it is because everyone hit vacation mode, but if you’re a buyer who got priced out earlier this year, it might be time to start looking again.