Fed implies rise in interest rates is inevitable
June 17, 2015
The big day is not here yet, but it is coming. The Federal Reserve concluded its meeting today without raising short-term interest rates, but it continues to remind everyone that such an action is more or less inevitable. The Fed's position on this might be best understood by revisiting an old English legend.
Janet Yellen at the water's edge
Janet Yellen's tenure as chair of the Fed has shown persistent effort to reduce the shock of policy change by providing signals to financial markets and business communities well in advance. Minutes from recent Fed meetings have made it clear that economic conditions will change monetary policy in certain aspects. In this way, Yellen's relationship to interest rates is like King Canute's relationship to the ocean's tide.
Somewhere around the beginning of the 11th century, King Canute ruled over England and parts of Scandanavia. Concerned that his subjects were developing too much faith in his ability to control events, he had his throne carried to the sea shore where he ordered the tide to stop coming in. The tide, of course, did not stop. The King told his subjects to view that as a demonstration of the limits of his or any other ruler's royal powers.
By sending signals over the course of several months that an interest rate hike may be on its way, Yellen can be seen as playing the role of King Canute. She knows that the business community and stock market do not like the idea of higher interest rates. She also knows they are inevitable at some point. Rates have been unnaturally low in recent years: the Fed has kept discount rates between 0 and 0.25 percent since the end of 2008, but over the past 50 years they have averaged 5.56 percent. With employment growth and inflation picking up, keeping rates near zero is unsustainable.
The bond market has certainly noted that conditions call for higher interest rates and has not waited for the Fed to make its move -- Treasury bond yields have risen in recent weeks.
Look for bank rates on the move
It is not just bond rates that have been getting a jump on the Fed's move toward higher interest rates. Although savings account rates on average remain near zero, a few banks have broken ranks and have started to raise their rates.
This represents an opportunity for bank customers to start earning more on their savings, but only if they take action. Banks raising savings account rates are still in the minority. When it finally comes, the Fed's decision to raise rates will not trigger an across-the-board increase in bank rates, but it will be a reflection of the fact that interest rate conditions are in the process of changing. Those changes mean the gap between the highest and lowest bank rates will likely widen, so the reward for rate shopping will become greater as the market adjusts to developing conditions.