I was asked not to write a column on politics this week, so I decided to write about economics. Right now, one of the top concerns of many people is the high inflation rate. There are many reasons given for the inflation increase, including the United States Federal Reserve monetary policy. The Federal Reserve has kept the interest rates historically low. In addition, the Federal Reserve has been buying government-backed bonds.
The stated goal was to help jumpstart the economy. It is debatable as to how helpful and necessary the Federal Reserve’s direction has been to reach this goal. However, their approach has benefitted two sectors of the economy: the housing market and the stock market. Homeowners can obtain a home equity loan at lower rates and for higher amounts. Low interest rates made it cheaper to borrow money to purchase a home. Thus, it should be cheaper to buy a home. The problem is that when more people look for a home, the price goes up. It may be cheaper to borrow long term based on the low interest rate if the amount necessary to borrow had remained constant. However, now that home prices have increased, whatever is gained in having to pay a lower interest rate may be eaten up by having to pay a higher price.
One group that is a winner are those selling homes, whether they are home-builders or current homeowners. They receive a higher price for their homes because of lower interest rates. Right now, there is still a shortage of homes to meet the demand, due to many homeowners waiting to sell their home with the belief that prices will continue to go up. They may be in for shock. Many homeowners in 2008 made that mistake and paid the price.
The stock market benefits from low interest rates because it is basically the only game in town to invest money. If you leave the money in the bank, the interest rate is paltry. Bonds have also not been a profitable alternative. Moreover, lower interest rates make it easier for individuals to buy stock on margin. Generally, the margin rate is lower when the Fed fund rate is lower. All of this leads to inflows into the stock market. The stock market kept going up because people kept on putting money into it.
Therefore, people who have assets or retirement plans, which are geared to stocks such as 401K, mutual funds, ETF, or brokerage account, and/or are homeowners, have done very well with the low interest rates.
For those on the lower income scale, who do not own a home or securities, interest rates have not been such a boom. Now inflation is hurting them more, since their wealth did not increase due to lower interest rates. Seniors who rely on social security are also hurt by high inflation since the yearly increase is based on the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) for the third quarter of the prior year, which could have a lower inflation number. The COLA (Cost of Living Allowance) for 2022 is 5.9 percent per year, which was lower than last month’s annual CPI number. For the homeowners and securities owners, they have a cushion to deal with inflation.
Not surprisingly, those who for months supported the Federal Reserve’s approach have started to turn on them and have gotten irate at the Federal Reserve for waiting too long to raise rates. Now the financial entities experts spend their time guesstimating how many rate hikes that the Federal Reserve will make and when it will happen. Also, these experts are all over the place when it comes to predicting the future path of the stock market. What they seem to generally agree on is that it is a stock picker’s market. In other words, a person who is in the market should not rely on investing in index funds, which have historically done better than managed funds. It must be mere coincidence that these money managers make their money actively managing their funds.
The last time the Federal Reserve had kept interest rates low it did not turn out too well. Federal Reserve Chair Alan Greenspan was thought a genius with his low-rate easy monetary approach - until it led to the financial crisis in 2008, which included the demise of Lehman Brothers and the implosion of the valuation of the housing market. Those who forget the past are bound to repeat it. So, tread carefully.