Will the Federal Reserve (the Fed) raise the federal short-term rate this year, early next year or later? There is no clear consensus on the much-debated answer — even among first tuesday readers.
We asked for your predictions and received an evenly divided response: 33% of you believe the Fed will raise short-term rates before the end of 2015 (as anticipated by first tuesday), while 34% expect rates to rise during the first half of 2016. Another 33% voted the Fed will hold off even longer, not raising rates until the second half of 2016 or later.
But we may see some Fed action sooner than that. Federal Reserve chairwoman, Janet Yellen, recently announced the awaited increase is expected later this year — a prediction shared by a third of our readers. With recent job numbers in mind, first tuesday estimates this is right on the mark.
A rate hike to follow job growth
Those who foresee deferred action by the Fed may cite the diminishing lending market as reasonable cause. Mortgage funds are slow to fill the market and interest rates are historically low – while spreads are high favoring lenders, not buyers – but this is due primarily to the Fed’s presently low short-term interest rates. A lack of investment opportunities is also leading to investors depositing their excess cash in bonds or with the Fed.
However, California’s accelerated job growth portends expansionary economic growth — and the beginning of the Fed’s rate increase — on the horizon. In June 2015, California saw a year-over-year increase of 482,300 jobs, a running trend in solid employment growth for over 12 months. Further, California employment surpassed the number of jobs held prior to the Great Recession, reaching 16.1 million jobs in June 2015.
Nationally, jobs are also on the path to recovery. As of June 2015, the national unemployment rate is down to 5.3% (below California’s 6.2%), according the U.S. Bureau of Labor Statistics.
Such improvements indicate the market is heading for a period of strong economic growth – prime time for the Fed to begin incremental increases in short-term rates to give them room to act when the next recession occurs.
Stock market bubble interference
On the other hand, those readers who are more pessimistic about the recovery and predict a delay in the Fed’s activity may have reason to be concerned. Despite the current outlook, the Fed may hold off if the present stock market bubble deflates this year, a sympathetic reaction to markets around the world and the expected rise in interest rates.
The trepidation and uncertainty stems from a rising trend in stock prices. In the first quarter (Q1) of 2015, stock prices remained unsustainably high with a price-to-earnings (P/E) ratio of 20.3, noticeably 31% above the historical benchmark of 15.5.
To recap: the stock market’s P/E ratio is the reciprocal of the capitalization (cap) rate, which is how buyers of real estate price their investments. A P/E ratio of 20.3 is equivalent to a cap rate of 4.9% – not economically viable as corporate expenditures are at an all-time low and profit margins rather large. Thus, stocks are overvalued and doomed to eventually shrink back down to their mean pricing again.
A deflated stock market bubble is sure to ripple through the economy, reducing personal wealth that has resulted from overvalued stocks. This shift will drive up bond prices and exert downward pressure on interest rates. In this scenario, the Fed is likely to postpone rate increases until the ripple clears out the market.
However, first tuesday remains optimistic, more so than our readers. With economic growth brewing, we don’t see the Federal Reserve waiting much longer to begin the awaited increase in short-term interest rates. The present situation is reminiscent of the initial Fed rate increases of 1984 and 1994, as recoveries were underway from a prior recession. Both rises adversely affected real estate pricing for sellers.
first tuesday giveaway
Want to take another shot at guessing when the Fed will raise short-term interest rates? Submit the week you predict the Fed will begin the hike in the comments. If you are one of the first three to guess the week correctly, you’ll win a $30 Starbucks gift card from first tuesday!
Here’s how to play:
- Select a week during which you believe the Fed will raise rates.
- Post the Monday of that week in the comments below (e.g. if your prediction is for the week of Monday, September 21-Friday, September 25, you’ll post September 21).
- Only the first three people who choose a particular week are eligible to win if that week is correct.
- Be sure to enter a valid e-mail address when posting your comment, so we can contact you.
- All comments need to be submitted by end of day Monday, July 27, 2015.
- We’ll await the Fed’s decision. If they raise rates during your week, we’ll send you a $30 Starbucks gift card.
Let the predictions begin!