Main Street: When Will The Federal Reserve Raise Interest Rates?

Source: Main Street

Author: Scott Gamm

As the Federal Reserve winds down its bond stimulus, which has kept interest rates low since the 2008 recession, investors are watching closely to see when the central bank will raise the short-term federal funds rate.

On Wednesday, the Fed released minutes detailing the June FOMC meeting. Speculations that the central bank's bond buying program, known as quantitative easing, would end in October were confirmed in the report. This suggests that the Fed believes the economy is strong enough to proceed without the central bank's help.

"If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting," the minutes stated.

Analysts expect the Fed to raise short-term interest rates, the rate banks use to lend to each other, in mid-2015. Fed Chair Janet Yellen spooked the markets back in March by telling reporters short-term rates could rise "six-months" after the bond buying program ends.

Short-term rates have been near zero since December 2008, a boon to the stock market, as low rates decrease borrowing costs for banks and boost investment. As the unemployment and inflation rates move closer to the Fed's targets of 5.5% and 2%, respectively, speculation is thickening over whether the Fed will raise rates sooner than next summer.

"I don't think the economy is as strong as the headlines believe," says Scott Carter, CEO of Lear Capital. "We'd have to see serious economic expansions during second quarter for the Fed to raise rates sooner than June 2015, which is the estimate even from the doves."

"Doves" refers to central bankers who favor easy monetary policy and low interest rates, while "hawks" denotes those who want to combat inflation with higher interest rates.

During the first quarter of 2014, the broadest gauge of economic output, gross domestic product, fell at an annualized 2.9%, according to the Commerce Department. While the unusually harsh winter in January played a role, there is evidence to suggest the economic picture isn't too rosy.

Bill Simon, President and CEO of Wal-Mart Stores, the world's largest retailer, said in a Reuters interview that improvement in the labor market isn't boosting consumer spending.

While last week's jobs report showed the addition of an impressive 288,000 jobs in June, problems remain in the labor force: the number of part-time workers rose by 275,000 to 7.5 million, according to the Bureau of Labor Statistics.

"They're jobs that don't build a middle class and generate discretionary income for individuals to spend," Carter adds.

Aside from jobs, bond yields indicate that short-term rates won't be raised sooner than next summer. The yield on the benchmark 10-year Treasury stands at 2.53%, compared to 3% towards the end of 2013.

"If interest rates were going to rise in nine or ten months, the first thing we should be seeing is 10-year yield rising, but instead it's dropping," Carter tells MainStreet. Bond yields and prices move inversely.
As for how a rise in short-term interest rates would impact ordinary Americans, the increase in borrowing costs for banks would be passed on to consumers, especially in the mortgage and auto loan markets.