Zero Interest Rate Zone

Financial focus
Saul Herrera Zero Interest Rate Zone
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Each year in our summer issue, we ask a group of the region’s leading wealth managers to help our readers navigate financial waters by responding to a question. This year, the question is:

In your opinion, what will be the ultimate impact of the Federal Reserve’s zero interest rate policy in the short term and the long term?

James Armstrong, Henry H. Armstrong Associates

In the short term, the Fed’s policy has punished the saver and rewarded the borrower. Debt-​heavy companies that would have gone bankrupt under normal conditions were able to refinance their debt at very low rates, and some were able go public after 2009 passed. However, the buyers of that debt, and those IPO shares, are likely to fare poorly in the future. Interest rates at zero have a distorting effect — asset values are pumped artificially high. When interest rates rise — as they must, once the Fed ceases its artificial maneuvers — market prices of certain assets (a 20-​year bond, for example) will decline sharply.

Greg Curtis, Greycourt & Co.

The short-​term impact will be nil. The long-​term impact will be to delay the economic recovery. The Fed knows its zero interest rate policy has outlived its usefulness, and it also knows that low short rates are an inefficient way to increase employment. More important, prolonged low short rates distort the economy because so many business and financial decisions start with the cost of capital. In other words, we know that the cost of capital is priced artificially today, but we can’t know what the true cost is. The U.S. economy will eventually get back on track, and when it does the Fed will claim credit. In reality, the economy would have improved much earlier but for the Fed’s short-​sighted policies.

Linda Duessel, Federated Investors

In the short run, savers will keep getting punished and bonds will become increasingly unattractive. But rate-​repression is bullish for stocks. It is rare to have bear markets when rates are so low. The long run is dicier. Textbooks tell us all this printing of money should spawn inflation and asset bubbles, which are painful when they burst, as we know too well. But we’re not alone in printing money — central banks all over are doing this. And it’s hard to find signs of bubbles or budding inflation — IMF head Christine Lagarde views deflation as the bigger threat. Ultimately, we may be headed for a prolonged period of lower rates, returns and growth. And we know how to get paid in such an environment — dividends.

Elizabeth Genter, Schenley Capital

Since peaking in the 1980s, interest rates have steadily declined, and this 30-​year trend has led to the biggest bond bull market in history. In September 1981, the yield on the 10 Treasury was 15.32 percent, tumbling to a low of 1.38 percent in July 2012, where the rates have remained. Since December, the Fed’s monthly purchases are being reduced but not eliminated. While this is a good thing (it couldn’t go on forever), the action has created tension in the stock market. In the near term, the Fed’s easing has forced investors to accept more risk and purchase lower quality fixed income vehicles at higher prices. The long-​term result of the Fed’s easing has created a stronger economy, corporate expansion and stronger balance sheets.

Dean Kartsonas, Shorebridge Wealth

I expect the short-​term impact of the Fed’s policy to remain favorable. Low rates will continue to add liquidity into the economy, which will likely lead to further stock market gains, increases in employment levels and improvements in the housing market. I am more cautious in the medium to long term. The key question is: When will the Fed increase interest rates? If rates are increased too suddenly, the economy may slip back into recession. Alternatively, if the Fed waits too long, it risks an acceleration in inflation. Due to its focus on improving employment trends, I think the Fed will hold rates lower for longer. This action will likely cause rising inflation levels and increase the attractiveness of stocks with exposure to natural resources, commodities and real estate.

Bob Kopf, Smithfield Trust Company

The lowering of the Federal Reserve’s policy rate — the Fed Funds Rate — to near zero was a timely and appropriate response to the financial crisis and recession of 2008. But that was more than five years ago, and there is little in the way of hard evidence to indicate that the very low level of the Fed Funds Rate is having a positive impact on the labor market or, for that matter, the economy as a whole.The Fed’s exceptionally easy monetary policy is sowing the seeds of inflation and encouraging excessive risk taking. In short, we believe that the costs and risks of the Fed’s zero interest policy far exceed its benefits. The time has come to start normalizing monetary policy.

Jack Kraus, Allegheny Financial Group

The impact is uncertain and will be dependent on the strength of the U.S. economy moving forward. The Fed may start to increase rates either in 2015 or 2016, so we are probably closer to the end of the policy than the beginning. A change in policy assumes the economy is strong enough to absorb these rate increases. A number of prognosticators are predicting hyperinflation due to the Fed’s policies.The probability of this in my opinion is less than 10 percent. The other end of the spectrum is deflation, which is just as or more damaging than hyperinflation. I would also give this less than a 10 percent probability. The reality will be most likely in the middle somewhere. The voices of the two extreme views are necessary, however, to guide policy from going to one extreme or other.

Mark Luschini, Janney Montgomery Scott

In the short term, the zero-​bound interest rate policy administered by the Federal Reserve supports low borrowing costs for consumers and businesses, and encourages investment in risk assets. The intention is to stimulate economic activity through increased spending, thereby facilitating a sustainable pace of domestic growth. The longer-​term fear is that capital misallocation may be engendered by the proliferation of cheap money, which could lead to distortions not as yet realized. In addition, the narrative associated with the term of zero percent interest rates, plus the inevitable shift in policy to higher rates, grows increasingly complicated because the distance from zero to equilibrium leaves ample room for an unpredictable market reaction.

Michael Maglio, PNC Wealth Management

Although fed intervention was effective in supporting economic recovery following the Crash of ’08 and the Great Recession, there have been short-​term effects, and potentially lasting impacts from the Fed’s zero interest rate policy. Notable positive impacts include low mortgage rates, rebounding home sales and prices, and low-​cost business credit, which has supported investment. Record-​low corporate borrowing costs have contributed to margin expansion, earnings growth, and exceptional stock market returns. The near-​zero rate policy has also precipitated undesirable consequences, such as diminished yields for savers, and the decimation of income for retirees. After saving for decades, many cannot garner fixed income yields sufficient to support their retirement lifestyles. The Fed has expressed concern that this low-​yield condition might promote excessive risk-​taking in the longer term.

Christopher McMahon, McMahon Financial

In response to the financial crisis, central banks worldwide began to cut interest rates in mid-​2007 and have remained essentially at zero ever since. This presents a challenge on several fronts, most notably to the near-​retirement workers, as well as new members to the workforce. In this environment, near-​retirement workers have the potential of taking on additional risk in the attempt to gain a higher return on their investments to enable them to retire on time. If they are unable to retire as planned, it means they stay in their jobs longer, thus affecting the labor market and new job availability and creation due to an individual’s retirement.

George Mokrzan, Huntington Bank

The zero interest policy reflects a highly stimulative monetary policy. It provides a historic level of monetary stimulus. Policy interest rates near zero help to bring down overall interest rates in the economy. Low interest rates make financing for consumers more affordable, helping them to purchase new cars, buy new homes, refinance mortgages, pay down debt and generally improve their finances. Low interest rates also help businesses invest.

Ron Muhlenkamp, Muhlenkamp and Company

The zero interest Rate Policy (ZIRP) was intended to boost the economy by encouraging borrowing: cheap money for buying houses, building plants and hiring people. Housing has partly recovered; building and hiring by companies have not. The benefit of cheap money has been neutralized by the uncertainty of its duration, along with tax and regulatory uncertainty, which discourages managers from making long-​term commitments. Short term, ZIRP has enabled companies and hedge funds to borrow money for stock purchases (bolstering the stock market), and negative real interest rates, which have lowered the incomes of retirees and squeezed the actuarial standing of pension plans. Long term, ZIRP will encourage the misallocation of capital and continued profligate spending by our politicians, neither of which is a benefit to the country.

Andy Paterson, BNY Mellon Wealth Management

The federal reserve’s stimulative monetary policy continues to support modest growth in the U.S. economy. Yet we don’t see inflation with respect to consumer prices as an imminent threat. Although the Fed has announced that it will slow its massive bond-​buying program later this year, the pace and timing will ultimately depend on the strength of the economy. We think it’s highly possible that interest rates will normalize gradually over the next several years, causing the Fed to shift away from its easy monetary policy. As a result, we think a more intense interest rate spike is likely to occur in 2017 or 2018. For our clients, we have positioned portfolios for an environment of modest economic growth, muted inflation, lower expected total returns, and gradually rising long-​term rates.

Brian Tarquinio, UBS Financial Services

Our economics group believes that all signs continue to point toward the Fed beginning to raise rates in mid-​2015. Perhaps more interestingly, within the Fed’s Federal Open Market Committee (FOMC) forecasts, there are hints that the expected pace of the rate hike cycle in 2016 will increase even further. That development is consistent with our long-​held view that the large balance sheet will require the Fed to raise rates more than they otherwise would to achieve the same degree of tightening. Given the consistency of the Federal Reserve’s statements over time and across communications channels and our concerns resulting from our view that the labor market is significantly tighter than the FOMC believes, we are raising our 2015 year-​end Fed funds target to 1.25 percent from 0.75 percent.

Andre Voicu, Fragasso Financial Advisors

The 2008 financial crisis left a legacy of near-​zero interest rates. The Fed action was initially required to ease market panic and avoid an economic depression. Near-​zero interest rates persist today. Many feared printing money would create inflation. Paradoxically, the opposite happened. Once rates reach zero, monetary policy loses some effectiveness because banks tend to hoard most of the newly printed cash. The Fed cannot fix the economy by itself. It can only build bridges. The government has a role in facilitating an environment conducive to business growth for a sustained recovery. Critics have accused the Fed of shortchanging savers with near-​zero rates. However, investors receiving the proper advice to build suitably balanced portfolios benefited from Fed actions as U.S. stocks (as measured by the S&P 500) and many other assets rose in value since then.

Jeff Wagner, F.N.B. Wealth Management

While there is no way to measure the economic effects of the Fed’s zero interest rate and quantitative easing policies, it is reasonable to assume that artificially low rates played a positive role in reviving the housing market, supporting stock prices and creating a better environment for consumers. Given the depth of the economic decline in 2008, there is no question that support was necessary. However, it was not free. The impact of low interest rates on savers has been and will continue to be a severe problem. We worry that the search for yield has caused savers to migrate into higher risk securities. For this reason, we encourage investors to assess the need to rebalance portfolios according to their long-​term risk tolerance profile.

Alison Wertz, Bill Few Associates

Historically, the fed’s policy has been limited to cutting the fed funds rate, but for five years the Fed has also employed an unprecedented policy of buying trillions of dollars of longer-​term debt securities to artificially reduce long-​term rates. Short term, this policy enabled the federal government to run up a trillion-​dollar budget deficit in order to support the economy while state governments, corporations and consumers repaired their balance sheets. Longer term, the impact will be an added level of uncertainty for years to come, due to a banking system awash in excess reserves, greatly increasing the risks of higher inflation and interest rates. This uncertainty could restrain current and future investment and ultimately produce a drag on the economy.

PQ Staff

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