3 Reasons Why Interest Rates May Drop in 2016
Rising Rates Wrong?
Many thought that the Federal Reserve’s decision in December to raise interest rates by .25% would be the end to our almost decade of low rates available for home purchase and refinance transactions. Why has this not been the case?
The move by the Fed was largely anticipated by the markets and was believed to be a signal to the end of the financial crisis and return to normalization. The Fed’s move had been built in to the overall pricing of the mortgage backed securities market resulting in a muted response to the Fed’s December policy decision.
There are many factors that play into the Fed’s ability to raise the Federal Funds interest rate. While the US economy, job creation, consumer spending and inflation are all factors closely watched by the Fed, Geopolitical events and the Global economy can also influence if and when the Fed will act to raise interest rates.
The outlook is that there may be as many as 4 additional rate hikes in 2016 (each of about .25%). But will the Fed be able to implement these increases to accommodate the gradual increase in interest rates they desire? I think it will be more difficult than many think.
Our recent economic recovery was due in part by the large domestic energy boom. Not long ago, Oil was trading over $100 per barrel and expansion of domestic oil production skyrocketed. This helped create many good paying jobs and huge corporate profits. This has seen a reversal with Oil now trading below $37 per barrel and corporate profits greatly reduced. This reduction in the price of Oil has also helped keep the overall inflation rate below the Fed’s 2% objective.
Currently, Oil prices have been driven even lower by Saudi Arabia. It is believed that this is an attempt by Saudi Arabia not only to disrupt the US Oil Fracking exploits which has helped boost our economy, but to also grab greater market share from regional players such as Iran.
The current economic data for the US economy arrears robust, but does reflect some weakness. While the unemployment data continues to come out strong, average hourly earnings has been flat. This may be due to the fact that the jobs currently being created are on the lower earnings spectrum.
The reported Unemployment Figures are greatly debated. Recent declines in unemployment can be exaggerated by lower participation rates. These figures do not necessarily account for those who are “underemployed – working but making much less” or have simply stopped looking for work.
While the US Economy has performed better than most other economies, it is still fragile. Increased interest rates can have a rippling effect throughout our Domestic economy. Increased rates can disrupt the housing market by making homes less affordable to many. Auto Sales, which have been very strong recently, could slow due to the increased rates. The fear would be that the increased rates will stall, or possibly reverse, the economic gains we have been able to make to date.
Many attempts have been made over the last several years by Central Banks to increase and maintain higher interest rates. Central banks in the Eurozone, South Korea, New Zeland, Australia and Japan have all tried and failed.
There is so much uncertainty within the global market at this time. China’s slowing economy, worsening European debt problems and an overall weak Emerging market also make this a difficult time for the Fed’s to increase interest rates. The Fed’s decision to leave interest rates alone in September of 2015 was partially due to China. As it turns out, their growth issues may have been understated and it is still unclear if the data we are being provided is reliable.
Increasing our interest rates affect these economies as well for their Dollar denominated debt. An increase to our rates will increase the interest payments due for the debt they hold creating a further burden on their economy. This may cause the Fed to be unable to raise our rates in an effort not to cause a reaction by these economies to devalue their currency causing us more problems with restraining the strength of the US dollar and the need to further increase our rates at a pace unsustainable by our current economy.
Geo-Political issues are transitory and may not last long, but do influence the market as well. Current issues disturbing the markets would be those like the dispute between Syria and Iran and North Korea. These event have the ability to scare investors over the effects these activities may have in the regional area.
Markets do not like uncertainty. When these concerns present themselves, what tends to happen is that investors with monies tied to productions within these regions withdraw their investments and look for a safe place to park that money until the concerns abate. A normal, safe place to park some of these funds would be the US securities market. The movement of these funds into the US securities market helps to place a cap on interest rates in our Mortgage Backed securities.
While these issues are more of a temporary nature, there has been plenty of instability to go around. If you combine our economic concerns, the Global economic realities and the Geo-Political concerns currently in play, I believe the Fed will find it very difficult to implement their projected rate increases. The real test will be in March. In order for the Fed to hit the anticipated 4 rate increases of about a .25% each throughout 2016, the first of these would need to happen in March.
What Does This Mean for You?
At the end of the day what this means for you is that now, and in the upcoming months, you should continue to enjoy the benefits of historically low interest rates. Whether you are looking to purchase or refinance now may be the time to take a look.