As the economy looks for a way to bounce back, plans to keep interest rates close to zero through the rest of the year by the Federal Reserve may have to be scrapped. It appears that extending low interest rates in 2015 may not happen, which for bank investors is incredibly bad news.
There are actually several reasons that this creates major problems. When it comes to setting bank interest rates, the Federal Reserve is pretty much in control. Therefore, when rates are set low for money the Federal Reserve lends to financial institutions and banks, other institutions and firms follow to include financing firms and banks.
For consumers in the market to purchase a new vehicle or home, this is great news. Obviously, the lower the interest rates are the more affordable the item being purchased becomes. For example the average interest rate for automobile loans is less than 5%. A low rate of 3.735% is also being offered on an average 30-year Fixed Rate Mortgage. While great for consumers, banks end up on the short end of the deal.
When interest rates are set low by the Federal Reserve, banks do well on money market accounts, checking and savings accounts, certificates of deposit, and other types of investments. Currently, these investments yield almost nothing and into 2015, will likely be unchanged. Rates are now average less than 1% across bank checking accounts in the US, hitting a near historic low.
People want to know why interest rates are being kept low for three more years by the Federal Reserve while in the meantime, bank savers are being punished.
The bond market is telling us to get ready for a long period of slow growth. The US bond market is a reliable indicator and used to forecast slow or low progress for the US economy moving into 2015. The primary indicator of progress in the economy is yields on 10-year Treasuries. As reported in August, these Treasuries were lower than expected, ending at 1.65% in 2014, down from 1.9% and for 2013, hitting 2.38% down from 2.7%.
In addition, traders in the futures market believe low rates will extend into 2015 so chances are good this is what will happen. Prior to the Federal Reserve holding a meeting in August to discuss fiscal policy, the percentage of traders in the futures market who felt low rates would be extended beyond this year was only 28% but as of this past week, that number increased to 66%.
Currently, sentiment pertaining to the economy is weak. In looking at the fiscal landscape, economist only see low inflation and weak growth, emphasized by the unemployment number reported last week that indicated millions of US workers had either stopped looking for employment or had simply given up.
Whenever there is a toxic environment specific to the economy, low rates are strived for by the Federal Reserve in order to encourage looser credit, as well as more consumer and business spending. With this, a struggling economy would gain some traction.
Considering the various reasons that the Federal Reserve is keeping interest rates low, a clear strategy of interest rates staying low throughout 2015 emerges. This is obviously bad news for the economy but for bank investors, an even worse scenario.