Economic Recovery: Running on Empty: The Historic Economic Downturn That Accelerated Last September Is Still Unfolding in 2009 Even as Some Predict a Recovery. despite Rising Unemployment, Some Analysts See "Green Shoots" of Optimism. Are Rising Interest Rates a Sign of a Burgeoning Recovery or Warning Clouds Heralding Unprecedented Levels of Inflation on the Horizon?
Birkner, Christine, Modern Trader
A bomb was dropped on the financial world and the economy at large when the financial sector collapsed in the fall of 2008, and the United States and the rest of the world are still working through the damage in 2009. Unemployment in the United States hit 9.4% in May, the housing market hasn't begun to recover from its three-year tailspin despite happy talk of "green shoots," and with the bankruptcy of General Motors in June, the U.S. auto industry has officially cratered. Experts say that this economy could recover, albeit closer to 2010.
The interest rate outlook will be based on the continued desirability of U.S. debt, which is being scrutinized more than ever, especially by the Chinese, even with the Fed buying Treasuries. Interest rate yields hit rock bottom in December, with the Federal Reserve setting its target rate at zero to 0.25%. With the Fed out of bullets in terms of the Fed Funds rate, it embarked on a quantitative easing program in an attempt to hold down interest rates. On March 18, the Fed announced a plan to purchase up to $300 billion longer-term Treasury securities over the following six months. While it had an immediate impact, it appears to be a case of diminishing returns as Treasuries have dropped (yields have risen) since the initial spike following the announcement (see "Buy bonds," page 20).
Mike Kimbarovsky, principal at Advocate Asset Management, expects the Federal Funds rate to remain unchanged in 2009 and for most of 2010. "With the budget deficit that we have, with the funding requirements, we're going to have to issue more debt. We're already issuing trillions of dollars of debt and our creditors demand higher yields to compensate for the extra risk from such a high deficit. Yields on Treasuries will go up, yields on mortgages will go up, three-month Libor will stagnate or go down," he says. "It's hard to predict around the world where [interest rates] are going to go. It's a competition of which countries can quantitatively ease faster. Yields all over the world will probably continue to increase as everyone prints money." He expects the equivalent Federal Funds rates for each country to be stagnant through 2010.
"We've seen some movement in the long-term side of U.S. bond markets showing less interest for the nominal bonds. That indicates that more investors are geared towards an inflationary environment," says Michele Gambera, chief economist for Ibbotson Associates.
Cary Leahey, senior managing director for Decision Economics, calls the dramatic jump in Treasury yields a return to normalcy in the bond market. "The sky is no longer falling, so you're returning to normal. At the same time, expectations of inflation which are tied to that, which had fallen to close to zero, have moved back towards 2% in the last couple of months."
Leahey points out corporate borrowing rates such as the BAA Moody's Corporate, the lowest investment grade, actually rallied from April to June, which suggests the economy is doing better. "We'd like to see the corporate market move back to normal but we don't want mortgage spreads, at least the Fed doesn't want mortgage spreads, to widen back to normal. The 4% Treasury rate would suggest a historically 5.5% mortgage borrowing rate, which is probably not consistent with any kind of recovery or stabilization in the housing market," he says.
In an effort to jumpstart the sputtering economy, the Treasury Department unveiled the American Recovery and Reinvestment Act in February, which includes tax credits for first-time home buyers and tax benefits for the middle class. Throughout February, Treasury released more plans to assist homeowners in reducing mortgage payments and a Capital Assistance Program to ensure that financial institutions have enough capital to lend, which included stress tests for banks that were designed to determine each bank's stability. …