Must-know: Why low rates could actually harm the US economy



Excessively low rates may be harmful to the economy. Lastly, as I mentioned in an earlier post, the Fed’s zero interest rate policy may actually be inhibiting economic growth and job creation in unintended ways. Among the negative side effects of excessively low rates: older workers are staying in the workforce longer, crowding out younger workers, and companies are wary of committing capital, delaying or reducing investment and hiring.

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In short, recent improvements in labor markets, firming inflation data and the harmful impact of excessively low rates suggest that the notion of maintaining monetary policy accommodation at “emergency levels” for these “unusual times” appears dubious. Supporting full employment and seeking general price stability are the Fed’s well-known statutory mandates, and the status of both suggests that rate policy should be in transition earlier than many anticipate, and that the Fed should move sooner rather than later toward a higher short-term funds rate.

Market Realist – The above graph shows how the participation rates for the above-60 age groups have been increasing. This can point to a crowding-out of the younger population. An older population affects the productivity of the country as a whole but can also impact the U.S. equity (SPY) and bond (BND) markets.

Since an older population usually is risk-averse, it tends to invest less in equities and more in U.S. Treasuries (TLT), pushing rates down further. But bonds had historically low yields since the crisis in 2008, resulting in pensions that did generate enough income as required—and especially after the strong blow that pension funds received on their equity allocations during the crisis.

That said, the price appreciation from the rally in bond markets triggered by quantitative easing did alleviate the problem to a certain extent.


Market Realist – The graph above shows the increased buyback and dividend payment activities by U.S. corporates as a result of the low rates. This is cause for concern. Corporates are using the easy corporate finance markets to raise money and using the money for buybacks instead of growth.

The biggest corporate players for buybacks this year have included Apple (AAPL), Exxon Mobil (XOM), IBM (IBM), and FedEx (FDX).

Though the September FOMC meeting indicates no change in Federal policy, you should pay attention to the revised dot plot. It shows the shift in median forecasts on interest rates. The median projection is 1.375% for 2015—up from 1.125% in June. The projection for 2016 is 2.875%—up from 2.50% in June 2014. This seems to indicate that higher and more aggressive rates will be adopted in 2015. A rate rise as early as the first half of 2015 seems very likely.

Read our series Must-read: The rate rise timeline you should watch for now to understand when the Fed is likely to raise rates.


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