Mortgage Update

Fed not likely to raise rates

Peter Hodson, Financial Post
Recently, there has been some loud talk about inflation and how the U. S.Federal Reserve is going to have to start raising interest rates soon inorder to nip inflation in the bud. When first confronted with this news,you may have said, "Hogwash! No way in this economic backdrop could the Fedraise rates, slow down growth and risk sending us into a steep 'double-dip'recession." . That certainly would be my view. It's unclear at this point even if weare coming out of recession, so it really would be premature to slow thingsdown at this point before any growth traction has been achieved.
However, let's not just make assumptions. Let's delve into history to seewhat the Fed has done in prior cycles.
The last U. S. recession was from March, 2001, to November, 2001, a periodof eight months. The Fed funds rate was 6.5% from June, 2000, to January,2001. In January of that year, the Fed lowered the rate to 6%, then went ona 12-month lowering frenzy during the recession and in the aftermath of the9/11 attacks. By year-end 2001 the Fed funds rate was 1.75%, with the Fedstill maintaining an easing bias.
Despite the official ending of the recession in November, 2001, the Fedmaintained very low interest rates for almost three more years. In fact, itkept lowering rates, down to 1% from June, 2003 to May, 2004. This strategyof keeping rates low despite no recession is now widely blamed as the reasonfor the creation of the housing bubble that popped in 2007. The Fed finallyraised rates in June, 2004, a full 30 months after the recession had ended.
In the recession of July, 1990 to March, 1991 (eight months) the Fed hadbeen easing or maintained a neutral bias since February, 1989. At the startof that recession, the Fed funds rate was 8.25%. By the end of therecession, it was down to 6%. Again, despite the recession being over, theFed kept jamming rates lower, all the way down to 3% in December, 1993. TheFed didn't raise rates again until February, 1994. In that recession, againthe Fed kept lowering rates for 30 months after the end of the recession.
Going back further into history, in the recession of July, 1981 to November,1982 (16 months) the Fed acted a little more quickly. In May, 1981 the Fedrate was 20.0%. By December of that year, the Fed had moved rates down to12%. In the spring of 1982, though, rates were back to 15%. But, showingsigns of confusion, by the end of the summer 1982, rates were much lower, at9.5%. The Fed was tightening rates again by September, 1982, and for aperiod of time investors had no idea what to expect, as the Fed moved ratesup or down seemingly at random for a period of 18 months.
In the energy crisis of the early 1970s, the recession lasted from November,1973, to March, 1975 (16 months). In November, at the start of the recessionthe Fed funds rate was 9.00% but by May, 1974, because of inflation fearsthe Fed had already raised the rate to 13%. Recession fears, however,ultimately ruled the day, and by year-end 1975 the Fed rate had been cut inhalf, to 4.75%. The tightening began anew, however, in April, 1976, 13months after the official end of the recession.
What can we conclude? One, it seems sometimes that the Fed is just wingingit, moving rates at random in response to short-term events. But it doesseem the Fed is unwilling to raise rates too quickly after any recession.
Based on the severity of this economic downturn, you would have to concludethe Fed is unlikely to risk a double-dip recession, and will keep the Fedfunds rate very low (now 0% to 0.25%) for a long time.
This may, of course, cause inflation, but for the time being, that is stillbetter than a giant de-leveraging economic death-spiral.

- Peter Hodson is a senior portfolio manager at SprottAsset Management.