Welcome to the CEO's monthly economic newsletter. The newsletter provides a basic narrative overview of recently published economic indicators for your reading pleasure. You should not rely on this information when making investment decisions, but rather seek professional advice from qualified investment advisors.
The U.S. Gross Domestic Product (GDP) second estimate came in at a rate of 2.2 percent in the fourth quarter, lower than many analysts expected and 0.4 points below the first estimate. Many believe the final reported adjustment will be near 2.0 percent. GDP grew 5.0 percent in the third quarter of 2014 and while that kind of growth is not anticipated during any quarter for 2015, it would be nice to have a number that pushes 3.0 percent or better.
To put that into perspective, China has set its GDP growth target at around 7 percent for 2015, its lowest in 11 years, focusing on quality over quantity as it overhauls its growth model. I guess they figured out that if they build it they do not always come, hence the focus on quality growth for 2015.
Meanwhile, the stock market rally has been running for 73 months. We just finished the best three months of job growth in 17 years as we approach full employment, and interest rates have continued at very low levels. Inflation remains well below the Federal Open Market Committee’s (FOMC) guidance of 2.0%, and based upon the modest level of wage growth coupled with low oil prices, there is not much reason to believe inflation will be taking off anytime soon.
Still, the big talk these days around the table for leading economists is, “When will the FOMC begin increasing the overnight Fed Funds rate?” Presently that rate has been at or near zero percent since December 2008. Janet Yellen, our Fed Chair, is just finishing her first year at the helm. When she took the position, she indicated Fed Funds would remain at present levels until about six months following the end of Quantitative Easing. Originally QE was thought to be ending in December of 2014, however it ended two months earlier. She’s become much wiser about making statements that are absolute, since it is highly unlikely we will see a Fed Funds rate increase in April.
Some of the past and present Fed Governors have been pointing to a rate increases as early as June but most likely in Q3. Rates near zero really imply an economy that is operating in a crisis mode. While that has been true for several years, our economy is much more stable and really does not require ultra-low interest rates for economic sustainability. Moreover, the FOMC needs to replace the ”bullets” in its gun for use during the next economic downturn.
The FOMC will likely move rates up at a slow but steady pace over several meetings. They meet 8 times per year generally for a couple of days each, so it could take about 2 years before Fed Funds can be normalized. Everything we hear these days is there is a “new” normal this or that. Traditionally, with inflation at 2.0% and employment in the low 5% zone, Fed Funds are priced near 3.0%. It looks like we could be there by the mid to later part of 2017 provided the Fed begins rate increases later this year.
The longer end of the yield curve, say 10 year and 30 year interest rates, will not likely move up in tandem with Fed Funds. Therefore, while home loan rates will move up some with Fed Funds, they will not likely move more than 1.00 to 1.50 percentage points. While this type of move in home loan rates is not debilitating for housing, it does suggest that today’s home loan interest rates are a bargain.
Dennis A. Long
President & Chief Executive Officer
Pacific Financial Corporation
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