The Federal Reserve’s decision to not extend two of its important emergency measures, the program to purchase $600 billion of Treasury issuances along with its $1.25 trillion program to buy mortgage debt, is already causing upward pressure to be placed on interest rates for everything from government borrowing, to mortgages, auto loans and credit cards.
In essence, the Central Bank is now acting in a countercyclical manner just as the business cycle has bottomed and turned the corner to the very early stages of expansion while headline unemployment is still 9.7% (and figures to remain uncomfortably high over the next several years).
For example, the rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31% last week, the highest level since last summer. Meanwhile, the Fed reported last week that the average interest rate on credit cards reached 14.26% in February, the highest since 2001, up from 12.03% when rates bottomed in the fourth quarter of 2008. It also found that rates for auto loans have increased to 4.72% in February from 3.26% in December.
The risk now is that any increase in borrowing costs will act to reverse the nascent gains in the housing market and in consumer spending. The Fed reported that during February, consumer borrowing in credit card debt and non-revolving loans fell by $11.5 billion, the most in three months.
Meanwhile, recent data on inflation indicates that the Fed might need to grow its balance sheet further. Core CPI increased just 1.3% in the year to February and the trend is slowing; the measure grew at a 0.8% annualized pace in the six months to February and by just 0.1% annualized in the most recent three months.
Core PCE, the Fed’s preferred measure, also expanded by 1.3% over the same period, below the average of 2.2% since 1990. The figure may fall to less than 1% over the next three to six months and end the year at 0.5%, according to Goldman Sach’s chief economist Jan Hatzius. The lowest it has been was 1.1% in 1963, based on data that start in 1960.
If this dis-inflationary trend continues, the Fed will be left with no choice but to again reflate the economy with an additional round of quantitative easing, which means it will print dollars in order to buy assets. And as we’ve seen, a concerted effort to battle falling inflation leads to depreciation of the dollar as investors search for assets to invest in as the purchasing power of cash diminishes.
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