When Will the US Prime Rate Go Up?

When Will The Prime Rate Rise?

Too many Americans are worried about their finances. The latest numbers out of the Labor Department say it all: As of August 2010, the jobless rate in the United States is 9.6%, and there are now close to 15 million unemployed people across the country. Those fortunate enough to have steady employment aren’t resting easy either. The National Bureau of Economic Research recently announced that the Great Recession, which began in December 2007, ended in June of 2009. However, since last summer, economic growth has been lackluster at best. Sluggish growth means that all types of companies may continue to cut costs by, among other possible actions, reducing their payrolls.

What do high employment and slow economic growth have to do with the US Prime Rate? Actually, everything. It’s because so many Americans are jobless, and because the economy is anemic with virtually no inflation, that the Prime Rate in the United States won’t rise any time soon; certainly not before the end of 2010.

The Prime Rate is used as an index for many financial products, like consumer credit cards, business credit cards, personal loans, home equity lines of credit and business loans.

The Federal Reserve (The Fed), which serves as America’s central bank, controls the Prime Rate, via the benchmark fed funds target rate. The formula is easy: US Prime Rate = (the fed funds target rate + 3). The target fed funds rate is the most important short-term interest rate in the United States. It determines the cost of overnight loans between American banks.

In response to the global banking crisis and Great Recession of recent years, the Fed lowered the target fed funds rate to a range of 0% - 0.25%. It was an unprecedented move by the Fed, one that caused the Prime Rate to drop to 3.25%, in accordance with the formula delineated above. Now, since the Fed has lowered its benchmark rate to its lowest possible level, that means the current US Prime Rate – 3.25% -- is also as low as it can go.

So when will the Prime Rate rise? Answer: when the Fed is satisfied that the US economy is not just growing, but growing sustainably, and at pace that will prompt companies to add new and previously laid off workers to their payrolls. Before the Fed will even consider raising the fed funds target rate, there will have to be a whole lot fewer than 15 million unemployed people in the United States, and threat of deflation will have to have been eliminated.  The Fed will likely be looking for an unemployment rate of around 5.5% or lower, with GDP growth of around 3%, for at least two, back-to-back quarters.

The Fed wants inflation to rise at a moderate pace, and to get as many jobless Americans back to work. That is, after all, the Fed’s dual mandate, it’s raison d’etre: price stability, and maximum, sustainable employment.

So if you want to know when the Fed will move short-term rates -- including the Prime Rate -- higher, then pay attention to the latest business news. If you hear or read that:

• nonfarm payrolls have been rising at a strong pace month-after-month, and
• the economy is growing and likely to continue expanding at a respectable pace, and
• the cost of goods and services, from food and energy to cell phones and hair cuts, are increasing at a moderate to strong pace (keep an eye on the PCE Price Index and the Consumer Price Index.)  The Federal Reserve has an inflation target of 2.0%.

then, at that point, the Fed is likely to start sending clear signals that a rate hike is in the offing.

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Futures Market 100% Certain U.S. Prime Rate Will Hold At 3.25% After The March 16 FOMC Monetary Policy Meeting

Yesterday, in testimony before the U.S. House of Representatives Committee on Financial Service, Fed Boss Ben Bernanke made it pretty clear that short-term rates, including the U.S. Prime Rate, won't rise any time soon. Here's a clip from Dr. Bernanke's prepared remarks:

"...Over the past year, the Federal Reserve has employed a wide array of tools to promote economic recovery and preserve price stability. The target for the federal funds rate has been maintained at a historically low range of 0 to 1/4 percent since December 2008. The FOMC continues to anticipate that economic conditions--including low rates of resource utilization, subdued inflation trends, and stable inflation expectations--are likely to warrant exceptionally low levels of the federal funds rate for an extended period..."

NB: It's widely accepted that "an extended period" means 3-4 Federal Open Market Committee (FOMC) monetary policy meetings, or about 6 months.

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As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 100% (as implied by current pricing on contracts) that the FOMC will vote to leave the benchmark target range for the Federal Funds Rate at its current level at the March 16^TH, 2010 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will remain at the current 3.25% after the March 16^TH, 2010 FOMC monetary policy meeting is adjourned: 100% (certain)
  
• NB: U.S. Prime Rate = (The Federal Funds Target Rate + 3)

The odds related to federal-funds futures contracts -- widely accepted as the best predictor of where the FOMC will take the benchmark Fed Funds Target Rate -- are constantly changing, so stay tuned for the latest odds.

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Futures Market 100% Certain U.S. Prime Rate Will Hold At 3.25% After The September 22 Monetary Policy Meeting

Dr. Ben Bernanke

President Obama has just announced that he is going to reappoint Ben Bernanke to another four-year term as chairman of America's central bank. Bernanke, a Republican, still has to get another stamp of approval from the United States Senate, but will likely be reconfirmed with little opposition. Bernanke has his critics, but many economists have praised the Fed chairman for his handling of the global financial crisis, crediting him for preventing a complete meltdown of the financial system, and for implementing innovative tools which the Fed has used to inject as much liquidity and confidence as possible into flagging financial markets.

I think it's safe to write that years from now, when the current recession is history, the vast majority of economists the world over will credit Bernanke with saving America from another devastating depression.

Here's a clip from President Obama's remarks made moments ago:

"...The man next to me, Ben Bernanke, has led the Fed through the one of the worst financial crises that this nation and this world have ever faced. As an expert on the causes of the Great Depression, I’m sure Ben never imagined that he would be part of a team responsible for preventing another. But because of his background, his temperament, his courage, and his creativity, that’s exactly what he has helped to achieve. And that is why I am re-appointing him to another term as Chairman of the Federal Reserve.

Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic freefall. Almost none of the decisions he or any of us made have been easy. The actions we have taken to stabilize our financial system, repair our credit markets, restructure our auto industry, and pass a recovery package have all been steps of necessity, not choice. They have faced plenty of critics, some of whom argued that we should stay the course or do nothing at all. But taken together, this 'bold, persistent experimentation' has brought our economy back from the brink. They are steps that are working. Our recovery plan has put tax cuts in people’s pockets, extended health care and unemployment insurance to those who have borne the brunt of this recession, and is continuing to save and create jobs that otherwise would have been lost. Our auto industry is showing signs of life. Business investment is showing signs of stabilizing. Our housing market and credit markets have been saved from collapse..."

Dr. Bernanke adding some comments as well. Clip:

"...It has been a particular privilege for me to serve with extraordinary colleagues throughout the Federal Reserve System. They have demonstrated remarkable resourcefulness, dedication, and stamina under trying conditions. Through the long nights and weekends and the time away from their families, they have never lost sight of the critical importance of the work of the Fed for the economic well-being of all Americans. I am deeply grateful for their efforts.

I especially want to thank my own family — my wife Anna and our children, Joel and Alyssa. Without their support and sacrifice I could not undertake this task.

The Federal Reserve, like other economic policy makers, has been challenged by the unprecedented events of the past few years. We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish, and in which Americans’ hard work and creativity can receive their proper rewards.

Mr. President, I commit today to you and to the American people that, if confirmed by the Senate, I will work to the utmost of my abilities — with my colleagues at the Federal Reserve and alongside the Congress and the Administration — to help provide a solid foundation for growth and prosperity in an environment of price stability..."

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• In other interest-rate news: Yesterday, the Bank of Israel, which serves as Israel's central bank, opted to raise its benchmark interest rate by 25 basis points (0.25 percentage point) from 0.5% to 0.75% for September 2009. A recent reading on inflation, in the form of the Israeli Consumer Price Index (CPI), show that prices are rising at a pace that would make any central banker nervous. For July, the CPI advanced by 1.1%, while economists were expecting a rise of about 0.85%.

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As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 100% (as implied by current pricing on contracts) that the FOMC will vote to leave the benchmark target range for the Federal Funds Rate at its current level at the September 22^ND, 2009 monetary policy meeting.


Summary of the Latest Prime Rate Forecast:

• Current odds that the Prime Rate will remain at the current 3.25% after the September 22^ND, 2009 FOMC monetary policy meeting is adjourned: 100% (certain)
• NB: U.S. Prime Rate = (The Federal Funds Target Rate + 3)

The odds related to federal-funds futures contracts -- widely accepted as the best predictor of where the FOMC will take the benchmark Fed Funds Target Rate -- are constantly changing, so stay tuned for the latest odds.

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