Rates likely to dip, soar
Many economic observers see signs of recovery in the U.S. economy and even of stabilization in Europe. They are forecasting a continued rise in interest rates.
If these observers prove correct, homebuyers face higher mortgage rates and investors can expect further losses in their “safe” bond portfolios. If these sanguine economic forecasts are wrong and recession rather than demand-led inflation threatens, homebuyers and bondholders may heave a sigh of relief.
The Commerce Department reports new home sales climbing and their value rising 12 percent over a year ago. The Labor Department showed jobless claims fell 19,000 to 326,000 last week. Annalisa Piazza, a fixed income analyst at Newedge Group of London, maintains that “there's been a signal that the global business cycle may have reached the bottom and the economy is recovering.”
Many economists agree with this forecast, and politicians seize gleefully on such opinion. Doubtless, many of them failed to forecast the 2007 recession.
However, the effects of the credit panic of 2008, together with the great uncertainties created by government over taxes, regulation and Obamacare, have left the consumer wary. The Federal Reserve's infusion of large sums of synthetic cash into the economy has bypassed ordinary people, creating an enormous and increasingly politically sensitive wealth divide. Real median household income remains at 1995 levels.
Nearly $150 billion in new taxes likely will be paid for from savings. Later, they will they be reflected in reduced consumer demand. This portends destruction $450 billion in consumer demand, starting near the end of 2013.
Already, anemic growth in gross domestic product highlights serious economic underperformance, rising by only 1.6 percent in the past year — far below the 223-year average of 3.8 percent. Reduced demand will worsen this situation.
Further, foreign economies are experiencing recession, reflected in falling commodity prices.
Unlike short-term rates, long-term bond yield reflects investors' expectations of perceived inflation rather than government- financed demand. This is crucial to gauging the interest rate outlook.
The popular misconception was that the Fed's injection of cash was inflationary. The yield curve steepened as long-bond yields rose. Conversely, talk of “tapering” off by the Fed is misconstrued as a sign that less government stimulus will lead to increased yields. Investors may soon recognize reduced Fed action as deflationary and buy long-term bonds, driving yields down.
Because of huge debt and serious mortgage default rates, the government cannot afford higher interest rates. Therefore, latent economic pressures for lower interest rates are increasing.
With GDP growth threatened by shrinking consumer demand and spreading international recession, it is likely that recession — rather than inflation — will threaten the major economies first.
If the popular outlook for inflation is replaced by fears of recession and lower interest rates, homebuyers and bondholders may get a second chance.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.