Interest rates are set to rise in September, at least according to a number of headlines and Internet commentaries, but maybe – just maybe – it might be worthwhile to step back and consider a different possibility. What if mortgage rates stay pretty much where they are or even fall?
Since December 2008 the Fed has maintained a zero interest rate policy, or ZIRP. It makes sense to believe that at some point this policy must end, in part because a lot of people would like to see higher rates, such as investors, bankers, savers and retirees.
Alternatively, ZIRP supporters, folks who want to see the policy continue, include mortgage borrowers, those with car payments, and federal officials who want to hold down interest costs on the federal defecit. In the housing sector, low rates mean buyers can afford larger mortgages and that greatly pleases home buyers.
Those who want ZIRP extended hope that the Fed will talk a good game about increasing rates but not actually do anything. In fact, this has already happened.
The Fed had told everyone that it would lift interest rates as soon as unemployment fell below 6.5 percent, but when the magic benchmark was reached such thinking was dismissed by the Fed as outdated and the country continued to be ZIRPed.
And then, of course, there was a widespread expectation that the Fed would raise rates in June, a month which came and went with no action on the interest front.
Higher Rates In September?
Now, the Fed is widely expected to raise interest rates in September but will that happen? There are several reasons to suggest that ZIRP may be with us longer.
First, current events impact the ability of the Fed to act.
“China's devaluation of the yuan, lower commodity prices, slowing economies in Europe and Asia, plus declining oil prices all make it difficult to raise rates," said Rick Sharga, executive vice president at Auction.com. “In the US, declining stock values may cause some investors to put their cash into bonds and mortgages, thus continuing the pressure to hold down mortgage costs.”
Second, the federal government has an $18 trillion deficit. Imagine how much bigger it would be with higher interest rates. No doubt government officials are keenly aware of this issue and have made their thoughts known to the Fed.
Third, the housing recovery is both real and fragile. The National Association of Realtors reports that 163 out of 176 metro areas had price hikes in the second quarter. However, broad geographic surveys may conceal underlying weaknesses: Steve Real Estate Economy Watch, reports that according to Weiss Residential Research almost half of the homes in the 10 largest markets actually lost value.
Lastly, it could happen that the Fed raises rates and many forms of interest will fall anyway, including mortgage rates.
Paul Davidson, writing for USA Today points out that “other entities flush with cash, such as federal home loan banks and money-market mutual funds, can't earn interest from the Fed and so they sometimes lend to banks at a lower rate.” He adds that insurance companies and pension funds could also make below-Fed loans.
This is not the half of it. Cash is sloshing around the world in huge volumes. By one estimate US banks have some $2 trillion in excess funds, which is one reason mortgage rates are so low. Many investors in Europe and Asia are now getting negative interest, money which could do far better in the US. Such investors are in a position to undercut the Fed today and they can undercut it more if the Fed raises rates.
Much of the Fed's power arises from the belief that it has the ability to control the economy, but lower mortgage levels after an action to raise bank rates would undermine the Fed's all-powerful image.
For instance, mortgage rates rose briefly after the Fed ended its quantitative easing (QE) program in 2014 and then went lower. Rates in mid-August 2015 are actually lower than a year ago, despite claims of imminent interest hikes.
If there is a September rate hike and mortgage rates stay roughly the same or even fall then what tools does the Fed have to guide the economy? That's a question no one will want to answer.