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Is the Era of Ultralow Interest Rates Coming to a Close?

By: C.Jay Engel

The Wall Street Journal writes on tomorrow’s FOMC rate announcement that “[a] long era of ultralow interest rates and bond-buying programs may be drawing to a close.” This is remarkable. The miniscule uptick from the .5-.75% range to a .75-1% range is hardly leaving behind ultralow interest rates. As can be seen in the chart below, a quarter percent rise in the Fed Funds rate will barely show up, when looking at rates from a longer-term perspective.

With the latest GDPNow forecasts coming in at a paltry 1.2%, the idea that the Fed is simply going to continue any sustained effort to bring rates up to historically normal levels seems quite the exaggeration at the moment. The entire model relied upon by the Fed’s economists assumes that raising rates into a slow growth environment is precisely the opposite of what must be done. Of course, their models rest on indefensible foundations and they therefore can’t even explain where either real economic growth or artificial booms originate (nor can they distinguish between them). 

Our era of suppressed interest rates is here to stay (at least while the Fed still has the delusion of control). That’s what the whole “lower for longer” theme is about. Aside from the fact that the Professionals who run our monetary policy subscribe to variations of the Keynesian vision and therefore “advise” low interest rates, there also remains the cozy relationship between the Treasury (government) and the Fed. Explained by David Howden:

For the US Treasury, Fed remittances are something of a free lunch. When someone buys a Treasury bond, the government must pay them interest. This applies to the Fed as well, but then at year-end the Fed remits the interest back to the Treasury.

The federal government paid out $223 billion in interest payments last year. The Fed remitted almost $100 billion back, leaving the net interest expense at around $125 billion. It’s not just historically low interest rates that are making it easier for the Treasury to borrow in a way that, if it were done by anyone else, would classify them as subprime. The Fed is also chipping in and helping out where it can. […]

Consider that since Treasury debt is almost never repaid in net terms (old issues are retired but replaced with new debt issuances), the true cost of financing the US government’s borrowing is not the gross amount of debt outstanding but the annual interest expense it faces. Viewed this way, nearly half of the Treasury’s borrowing was financed by the Fed last year. Absent these Fed remittances, Congress would need to look at either an alternative funding source (though I am not sure how many takers there are for the Fed’s $2.5 trillion Treasury holdings) or make some serious cuts.

Regardless of what happens tomorrow (and it looks like there’s going to be a hike), the idea that this signals the close of the Fed-induced low interest rate era is quite the exaggeration.

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