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Federal Reserve poised to raise interest rates in 2015 or 2016

When it comes tracking economic recovery, Rob Sabo says economists like to see a V-shaped graph; that is, GDP growth goes down as it did in 2008 and then shoots right back up as it often has in the past.

Unfortunately, the 2008 recession “or what some have referred to as a depression,” hasn’t followed that pattern, according to Sabo. Instead, it went down and is now moving almost horizontally in an L-shaped pattern at an agonizingly slow pace.

“Everyone always hopes that when we go into an economic recession that you come out of it using the V model,” says Sabo, managing director of global financial markets for RaboBank, who spoke at the Agricultural Council of Arkansas annual meeting in Little Rock. “We’re actually following the slow version of the L model.

“The bottom of that chart says the L can last up to five years. Well, we’re in year six. We’re still slowly crawling out of the abyss. Technically, the recession ended in June 2009. But we still have problems like issues with unemployment. And it doesn’t necessarily feel to all Americans like the recession is over.”

Sabo said a number of economic barometers are indicating the U.S. economy is in relatively good shape compared to the remainder of the world. Unemployment is currently running at 5.7 percent, which is only slightly above where the Federal Reserve Board prefers it to be (at 5.5 percent). Ten-year treasury notes are at 2.03 percent; the Fed funds target rate is effectively at 0.0 percent and GDP grew at the rate of 2 percent in the third quarter of this year.

Normally, when the economy begins to recover from a downturn, consumers respond enthusiastically, increasing purchases and decreasing savings. “We don’t have that today,” says Sabo. “In fact, a recent Gallup poll indicated 52 percent of Americans still think the economy is going backwards.”

Investment low

One of the reasons for the slow recovery is that business investment remains low. “We’re at a record, all-time high for corporations having cash on their balance sheet,” says Sabo. “Companies are not investing; they don’t see prospects for growth; and they’re still afraid of a few things we’ll talk about.

“We have a new health care package, we have financial service regulation, we had a financial service debacle that led us into the 2008 recession, we have regulatory changes, we have tax code changes. I think there are still a lot of aftershocks throughout the country for corporate America and for individuals from 2008 to roughly 2013.”

All of those have led to even more uncertainty than usual over what the Federal Reserve Board will do about interest rates. With the rate effectively at zero, the Fed cannot lower rates any more than they currently have.

Sabo believes the Fed will attempt to return interest rates to more "normal" levels in 2015 or 2016, pushing them up to 1.25 percent, which would be a significant increase given their historically low levels since the beginning of the 2008 recession. 

"It looks like that (Fed Funds Rate) target is going to rise in the next year to 18 months and get back to what's considered a more normal level," said Sabo. "But former Fed Chairman Bernanke has been quoted as saying he does not expect the fed funds rate rising back to 4 percent in his lifetime."

The U.S. and other governments have been trying to fight their way out of the economic doldrums by pumping more liquidity or increasing the money supply to try to boost the economy.

Temporary effect

“The tricky thing about this is that it’s temporary, it can’t last forever and it has future ramifications,” said Sabo. “That’s because central bank liquidity drowns out systemic and fundamental risks, causing assets to rise regardless of fundamental weakness.”

The balance sheets of central banks around the world “have ballooned,” he said while they tried to fight recession. “The Federal Reserve has blown our balance sheet up by an additional $5 trillion. They were putting $80 billion a month of liquidity into the economy for several years.”

Another factor impeding a “normal” recovery is what’s happening in the housing market. Although long-term interest rates are at a relatively low level of 2 percent, home mortgage applications and housing prices are falling. “Mortgage applications are at an all-time low since 2004,” he said. “People aren’t even asking for mortgages because, in most cases, they know they won’t get them.”

Ben Bernanke, the most recent chairman of the Federal Reserve prior to the current chair, Janet Yellin, was recently denied a mortgage because he had no credit history. “He had worked in his present job less than a year so, even though he’s earning nearly a million dollars a year he couldn’t get a mortgage.”

Consumer spending is expected to get a boost from falling oil prices. But the latter cuts both ways because of the interconnectedness of the world’s economies. “For every $10 decline in the price of oil, Russia loses a percent of its DGP growth,” he said. “With oil prices declining about $50 a barrel since June, that’s 5 percent, which puts it into the negative.”

Russia isn’t alone in this although the impact of falling oil prices on its currency – and the uncertainty over what it might do in the Ukraine – have captured the world’s attention. Canada, Norway and Mexico, all major trading partners of the U.S., are also seeing declines in their economic output.

75th Anniversary

Despite the bearishness of some of Sabo’s comments, most Agricultural Council of Arkansas members seemed upbeat, in part, because the organization was celebrating a major milestone.

“This is a very special year for the Ag Council as it marks our 75th year since our founding in 1939,” said Rick Bransford, Ag Council president and a farmer from Lonoke. “Our 2014 Annual Meeting was an opportunity for all of us to reflect on our past, honor our history, pay respect to our predecessors, and recommit ourselves to this organization and its mission.”

“The Ag Council has such a rich tradition in Arkansas,” said Ag Council Executive Vice President Andrew Grobmyer. “It's a great organization with strong leaders who are committed to building a better future for agriculture in Arkansas. We are the only organization in Arkansas strictly focused on representing the row-crop industry, and we take this task seriously. We want to live up to the expectations set by our founders 75 years ago."

To read more, visit Agricultural Council of Arkansas - Promoting Agriculture since 1939.

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