When are rates really gonna go up?

[hipmatt]

When do you guys feel the fed will have the guts to increase rates significantly? We all know that inflation is a problem, more so than we are to believe, and the dollar has lost around 30% of its value against other currencies. To me this is the real question, because they have been postponing it so long. Current rates are relatively low, these homeowners have no idea where rates could or should be. If the rates were to go up, like they should, imagine the effects on the already limping along housing sector.

[kev374]

my guess would be 2007 Q2 at the earliest…not before that. It’s prudent for them to increase rates right now but I think they will holdoff at lease 2 quarters.

[brian_in_la]

My guess is that they don’t raise rates. The chinese need to loosen their currency and let it rise against the dollar. Hopefully they will (continue) to do so slowly and we will have a nice gentle fall over the next decade. I agree currency shocks are bad. But, weaker dollar=good. We buy fewer imports and sell more exports. Wail about M3 (M9, whatever) and housing prices all you want, but until the CPI shows real action or there is a dam-busting currency crash, the probability for raising rates is about zero for 2007. The european central bank (alert: “rumors via bloomberg”)has indicated it is not worried about a weakending dollar till it hits 1.45 (!) versus euro. So, don’t expect any help in coordinating walking the dollar back up. Given the doom and gloom expectations about the housing market on this site – I would expect less worry about inflation….real-estate busts are nice inflation killers (see: Japan, the last decade or two). Sometimes too nice. I too long for an end to the free-money decade, but I worry about deflation as much as inflation in the years ahead.

[powayseller]

I don’t think they’ll raise rates, since inflation goes down in a recession. According to Nouriel Roubini, the next Fed move will be a rate cut in early 2007 to stimulate the economy after it’s clear we’re in a recession.

[Wiley]

I’m of the opinion it doesn’t matter whether they cut or not. It only matters whether they are behind the curve of the bond market at this point in the game. Which they are and have been. Realistically the easy money regime has created so much leverage to this point I believe a cleansing is written in stone.

I don’t expect much from exports as we’ve already sent our manufacturing base overseas.

[powayseller]

Some of our exports go into products made by the Asian export-oriented countries, and sold to us. So our recession will first hurt the Asian export countries, and then trickle down to us by reducing our exports to them.

[PerryChase]

One thing is not yet quite clear to me is why would the Europeans support a strong Euro? Don’t they have export and employment to worry about?

[Nancy_s soothsayer]

I agree with brian_in_la. There is a probability of deflation in future years. In grammar-speak, inflation is past tense and deflation is future tense. So, methinks, it is still safe to hoard cash in US CD’s and dollars. Grocery store prices for eggs, meat, grains and milk will remain reasonable with deflation. If you normally travel abroad however, then hold your cash in foreign currencies.

[davelj]

My best guesstimate is that long rates aren’t going to move much from here (maybe decline a bit) but that short rates will decline next year and into 2008. The high inflation we’ve seen over the past 10 years is in the PAST (by definition) – it’s probably over for a while. So, while the government’s been reporting 3% inflation, the real rate has probably been more like 5% after adjusting for hedonics, substitution effects and the use of owner-equivalent rents (instead of housing prices). But now housing prices are already high (and moving lower), oil is already high (and probably won’t be increasing at the same rate it has over the last few years), commodities are already high (and not increasing at the same rate as the last few years)… you get the picture. So, the big inflation moves have probably already happened for this long cycle. My guess is that for the next 5-10 years the reported inflation figures will actually be roughly what the real inflation rate is, or 3%-ish. Housing prices will decline but it won’t show up in the CPI because use of owner-equivalent rents smoothes the series on both the upside and the downside. Commodities may increase but at a decreasing rate. We’ll probably get a bit of import inflation due to a declining dollar but I don’t think it will offset the other stuff. So, again, it’s just a guess but I think the “real” inflation rate is actually going to be reasonable over the next 5-10 years, which means short rates would decline 150-200 bps over time and long rates would stay about where they are, give or take 50 bps. The problem is for those people who have owned fixed income over the last decade, because interest rates were set by the market based on the government’s reported inflation figures, which were much lower than the real inflation rate. These people have been screwed and don’t fully know it (although they may sense it when they look at prices around them). But that’s the past; that doesn’t matter going forward.

[Anonymous]

davelj, what you say makes sense. But, what’s different this time is the huge, huge stash of dollars sitting overseas, or locked up in the Treasury on behalf of folks overseas. Never has been seen before in U.S. history.

Please tell me why you don’t think those dollars will come out in into circulation, giving us big time inflation.

Your analysis makes sense, and what you lay out would play out in any other downturn. But account for those excess, uncirculated dollars and tell me what you come up with.

[SD Realtor]

I very much agree with davelj as well. Unfortunately I think this fact will slow down the depreciation rate of the housing market, not kill it, just slow it down.

JG your point is good but in reality, if all those billions and billions of debt that has been purchased by southeast asia was pulled off the table I think the effects would be somewhat catastrophic don’t you? Bigtime inflation is putting it nicely.

SD Realtor

[powayseller]

jg, the money is already in circulation. It’s responsible for the big bubbles in assets, and for funding all our consumer spending. It’s the money used by Visa and MasterCArd, by private equity financing, buying flaky exotic mortgages, and government debt, US equities, etc.

So the question is *not* what happens when the money goes in circulation, because it already is (in assets though) but rather what happens when the money is moved out of US assets?

Where will it go, and how much will long term interest rates climb when the demand for US Treasuries declines? Something like 50% of our US Treasuries are held by foreigners.

When the foreigners sell off dollars, the demand for dollars goes down, lowering their value. That means our exports will be cheaper and our export trade will improve, possibly. It also means our imports will be more expensive. I believe our inflation is held low by cheap imports from other countries, but with a lower dollar, that would no longer be the case.

This is a question that I wish Roubini would address, but I guess nobody really knows. If not gold, then what?

[Anonymous]

I disagree with you, ps, that dollars accumulated by the Japanese and Chinese are in circulation.

From the San Francisco Federal Reserve Bank:

http://www.frbsf.org/publications/economics/letter/2005/el2005-17.html

"…Most foreign exchange reserves (such as the dollars owned by the Japanese and Chinese) are held in the form of dollar-denominated securities (such as T-bills/notes/bonds); one reason for this is that foreign governments like the highly liquid market for U.S. Treasury securities…"

"…The sale of dollar-denominated reserves (such as T-bills/notes/bonds held by the Japanese and Chinese) could have negative effects along several dimensions of the U.S. economy. First, it would tend to depress the value of the dollar vis-à-vis other currencies (as the dollars come flooding into circulation)…"

Lastly, a quick read of Setser & Roubini reiterates the points above:

http://www.foreignaffairs.org/20050701faresponse84415/brad-setser/how-scary-is-the-deficit.html

I have no idea why you think that the dollars accumulated by the Japanese and Chinese and others are in circulation.  $2.1 trillion of those dollars are 'on ice' at the Treasury.

Remember, the entirely separate source of financing for the '90s U.S. stock market boom then subsequent '00s U.S. real estate boom was, in large part, the cheap yen printed and made available via credit by the Bank of Japan in the '90s.

[powayseller]

jg, I’m sorry I’m having such a hard time explaining this to you.

The money that came here is invested AND SPENT. It is not sitting in a vault in China. THe money is spent on buying Treasuries, ABS, MBS, equities, and so on. So the money has been spent, and the effect was to drive up asset prices and push down yields on government bonds. The money was used to buy overpriced homes, fund your neighbor’s Visa purchases, IBM’s corporate bonds, derivatives, and so on.

Where do you think all that money came from to create this housing bubble? Who is lending subprime borrowers 500K on stated income? It’s the FCB money!!! THere is no such thing as money on ice. This money has created the credit bubble!

Furthermore, foreign central banks (FCBs) that wish to keep their currency from appreciating against the dollar, are printing their own currency in equal amounts to what is coming into the country from their exports, so there is a double whammy of liquidity. First we send them dollars which they have to print to convert, and then they send those dollars back and create asset bubbles.

So the question is, as I said before, what will happen when those dollars are removed from Treasuries, equities, collateralized mortgage obligations, mortgage backed securities, asset backed securities, government and corporate bonds, and divested into euros, yen, gold, etc?

Nothing is “on ice”. Money always has an effect, and the effect is to inflate assets and create more liquidity.

The effect of that money is already here: the long end of the yield curve is low, despite Fed attempts to raise interest rates. They cannot control the end of the yield curve because of the large sums of dollars sent here by FCBs.

You should read the Flow of FUnd reports. I think the MBS market is bigger even than the Treasury market, or right behind it. THe Chinese and Saudis have been using the money that you claim is “on ice” to buy all those exotic loans!

[Anonymous]

“THe money is spent on buying Treasuries, ABS, MBS, equities, and so on.”

After the Bank of Japan buys a U.S. Treasury security from the U.S. Treasury, where does that dollar sit? At the U.S. Treasury (and out of circulation).

Money isn’t ‘spent;’ it’s exchanged for something of value. The Japanese get a U.S. Treasury security, and the U.S. Treasury gets a dollar.

[Author]

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