Can U.S. Interest Rates Ever Be Allowed To Rise, I Ask Again Three Years Later?

Can U.S. interest rates ever rise to 'normalized' levels? And in our new world, what exactly would 'normalized' look like? An interesting question for sure in the context of pandemic, a flailing economy, tepid inflation and rampant unemployment!

Spoiler Alert: The simple answer is that of course they can in the event of runaway inflation and/or an overheated economy, but in light of $26 trillion in federal debt that will soon rise by at least $1 trillion through additional stimulus (not to mention budget deficits for the foreseeable future), the question is whether the Fed will continue to do whatever it can to keep them low in order to try and keep the United States somewhat solvent?

Currently interest payments constitute about an 8% share of the federal budget, but imagine how that number would balloon were rates to rise even 1%.

As the owner of a title insurance company dependent on a vibrant real estate market, the hope would be that the 10-year treasury yield and by extension mortgage rates, will continue to present an attractive environment for buyers.

With 30-year mortgage rates now with an astounding 2% handle, financing levels are certainly attractive although qualifying may have become more difficult.

This question about interest rates was originally asked by me in an article here July 24, 2017 when the 10-year treasury was 2.25% and the unemployment rate was 4.3%. An argument at the time could certainly have been made to begin normalizing rates 7 or so years after the financial crisis crushed the economy.

But interest rates were not destined to rise, unemployment fell even lower, inflation remained tame and the economy exhibited what was termed as 'strength' despite the deficits we were running as a country.

Then Came Coronavirus!

When coronavirus, or Covid-19, officially entered global vernacular and the economy was effectively shut down, the 10-year treasury fell from about 1.60% (during what was termed as a period of economic expansion) to its current .60%.

The federal debt rose from an eye-popping and unsustainable level of approximately $23.2 trillion at the beginning of February 2020 to the current level of approximately $26.5 trillion with more trillions to come as the Congress mulls more stimulus!

So, can 10-year treasury rates ever normalize to a level of even 4% without blowing-up what is already a bloated and teetering on-the-edge federal budget?

This is a look back to 'Can Interest Rates Ever Rise' and I would love to get your thoughts...

Can Interest Rates Ever Rise written July 24, 2017 by Hallmark Abstract Service CEO Mike Haltman

While interest rates have risen from depths that saw the 10-year treasury yielding 1.36% on 7/3/16, to 2.25% today, given Fed plans to tighten and pledge to shrink its balance sheet should rates be even higher?

The Fed will typically engage in the monetary policy of tightening and lift the Fed Funds rate when the two key components of its mandate, full employment and inflation at its target rate, indicate that it’s warranted to do so.

One could most definitely make the argument that with an unemployment rate of 4.3%, lowest since the 4.4% in October 2006, that employment is in good shape. And while some metrics within the employment report might suggest otherwise, this is a number that the Fed would likely consider as evidence for strong consideration of a tightening stance.

As far as the Fed’s 2% target inflation rate, whether these numbers fit the mandate is slightly less clear as the chart below shows:

But, Can The Federal Reserve Ever Really Normalize Interest Rates?

Are current treasury yield levels appropriate, or are they telling us that the ‘strength’ in the economy may not be lasting, that employment may weaken and/or that inflation may be tepid for some time to come?

Perhaps, but could there be another factor at play that may also keep the Fed from tightening to the point that interest rates become historically normalized?

In other words, if ‘normalized’ yields for the 10-years treasury were somewhere between 4% and 6% from 1990 through the financial crisis, can the Fed reasonably ever bring them back to that level?

Or, will the term normalized interest rates come to mean something much different from what Americans have been used to?

After all, if the economy is reported to be doing so well, can’t the average American tolerate an increase from current levels?

And can the federal government reasonably manage the increased debt service that would be incurred from higher rates, given the country’s massive and ever-growing outstanding debt?

Consider this statistic and the answer to the prior question may in fact be no!

In December 2016 the Federal Reserve raised its target for the fed funds rate by .25% to a target of 1.0% – 1.25% and, according to a TransUnion analysis, 63 million Americans holding adjustable-rate consumer debt were affected. These consumers will pay less each month when interest rates decline and pay more as they rise.

This hike that translated into an average increase in payments of $18, ‘created a challenge for 1 million consumers who were delinquent in their mortgage payment by the end of March…

Historical Fed Funds Rate

…TransUnion cautioned consumers and lenders, saying while this study showed only 1 million consumers were impacted in the first quarter, it did not examine long-term impacts of a rate hike. For example, many consumers could be dipping into their savings accounts to meet the new obligations, and could eventually exhaust that source of funds.’ (Source)

So therefore, if a .25% hike and an $18 increase posed a hardship for 1,000,000 consumers, how much more of an increase can consumers tolerate?

I suppose we shall see!

Michael Haltman

CEO, Hallmark Abstract Service

[email protected], (646) 741-6101