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 December 15 FOMC Monetary Policy Meeting

If you've been wondering when the Fed is going to start a cycle of raising short-term interest rates, the one macroeconomic figure you need to pay attention to is the unemployment rate. That's because the Bernanke Fed is confident that the nation's jobless rate is going to remain stubbornly high well into 2010 and likely beyond, which in turn will serve as a check on inflation. The Fed is still focused on pumping as much stimulus into the economy as it possibly can, to get the economy back to durable growth as soon as possible. It doesn't want to choke off an economic recover by raising short-term rates too soon, but it also doesn't want to keep rates too low for too long, and spark and raging inflation problem down the road. But here's the bottom line: the Fed believes that high unemployment together with continued housing market woes will act as a powerful economic sedative, keeping both consumer and wholesale prices under control.

Many investors are worried that the Fed is going to have an economic growth bias for too long, and that it will tolerate some inflation in exchange for growth. Just look at the price of gold as one piece of evidence: New York Spot was at $816.30 on November 28, 2008, and closed at $1,176.70 a few days ago (on November 27, 2009.)

Many are also worried about the current state of the dollar, but I'm not. The dollar is cyclical. It's been very low before, and has bounced back every time. When the economy returns to sustainable growth and the Fed back off from being the dominant force in the economy, the dollar will strengthen again, as simple as that.

So, does the Fed have it right about weak employment keeping inflation in check? I think so. With so many Americans out of work, or struggling with reduced hours, or forced to work part-time, consumer spending will be weak for some time. Exacerbating the jobs problem: too many homeowners are upside down with their mortgage; if they sell they lose big, and there's no home equity to tap into, the same home equity which supported strong consumer spending before the housing bust.

The above economic woes are acting as a strong disinflationary force in the economy, and will continue doing so for years -- yes, years.

So don't be surprised if the Fed keeps short-term rates -- including the U.S. Prime Rate -- at superlow levels throughout 2010.

Of course, for the latest and most accurate rate forecast, stay tuned to this blog.

Housing Market News: Some Good, Some Bad

OK, first the bad. The Mortgage Bankers Association (MBA) recently reported that mortgage delinquencies have set a new record high. Here's a clip from the MBA press release:

"...The delinquency rate for mortgage loans on one-to-four-unit residential properties rose to a seasonally adjusted rate of 9.64 percent of all loans outstanding as of the end of the third quarter of 2009, up 40 basis points from the second quarter of 2009, and up 265 basis points from one year ago, according to the Mortgage Bankers Association’s (MBA) National Delinquency Survey. The non-seasonally adjusted delinquency rate increased 108 basis points from 8.86 percent in the second quarter of 2009 to 9.94 percent this quarter...The delinquency rate breaks the record set last quarter. The records are based on MBA data dating back to 1972..."

And now the good: sales of both existing (preowned) and newly built homes improved during October 2009, thanks in no small part to Uncle Sammy's $8,000, first-time homebuyer tax credit (there's also a tax credit of up to $6,500 available for longtime homeowners who purchase a replacement home.) That's good news for the housing market in general, but there's more: the credit has been extended. For more, check out this IRS page.

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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 December 15^TH, 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 December 15^TH, 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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Futures Market 98% Certain U.S. Prime Rate Will Hold At 3.25% After The August 11 Monetary Policy Meeting

It's been a volatile week in equities markets, so we're going to mix this Prime Rate forecast with a bear market update.

Since closing with record highs on October 9, 2007, the DJIA has now lost 6,018.01 points (42.486%), while the S&P 500 Index has shed 686.02 points (43.831%). The record high for the DJIA is 14,164.53; for the S&P 500 Index it's 1,565.15.

Year-to-date, the DJIA is down 629.87 points (7.177%), while the S&P 500 is down 24.12 points (2.67%).

OK, so now for some positive bear-market news: since the bear-market low of March 6, 2009, the DJIA is up by 1,519.58 points (22.93%), while the S&P 500 is up by 195.75 points (28.644%).

• There's also good news from an energy perspective: crude oil for future delivery closed at $59.89 per barrel in New York today. On July 11, 2008, crude closed at $145.08 per barrel. That's a year-over-year decline of $85.19 (58.719%). No one wants high energy prices to slow down an already drawn-out economic recovery, so most of the economic world is hoping that crude oil prices remain tame. However, lower oil prices also mean that global demand for energy is relatively weak, which could mean that a return to prosperity may be further down the road than many economists are currently predicting.
  
• There was also some halfway decent news from the Labor Department yesterday. Though the unemployment rate for June 2009 was reported at 9.5% in a previously released Labor Department report -- and will likely rise this month -- new claims for unemployment benefits dipped below the 600K mark for the first time in countless weeks. For the week that ended on July 4, 2009, 565,000 Americans applied for jobless benefits. This news, however, was tempered by fact that continuing claims for jobless benefits surged by 159,000 to 6,883,000.

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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 98% (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 August 11^TH, 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 August 11^TH, 2009 FOMC monetary policy meeting is adjourned: 98% (very likely)
• 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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