John's Outlook on Interest Rates and inflation for 2018
No one can predict what is going to happen when it comes to interest rates and inflation. In my opinion, though, given the state of the economy and many other factors, I do not believe there will be any drastic increases in long-term interest rates in the near future.
Over the last decade, inflation has been consistently around 2%. Historically, the Federal Reserve has needed higher inflation to raise short-term interest rates which in turn correlates to a rise in long-term interest rates. At present, the Federal Reserve is in a quandary because low-interest rates historically have resulted in a growing economy with rising inflation. However, this was not the case over the last seven years of anemic economic growth with the Federal Reserve's retention of extremely low, short-term rates.
The depressed global markets over the last seven years, some countries with extremely low-interest rates others with negative rates, caused a flight of capital to U.S. Treasuries for quality and liquidity which has helped keep interest rates down.
The size of the National debt is now over $20 trillion; it's largest in history. Raising rates will drastically increase the interest payments on the National debt, thus further compounding the debt problem. This is another reason why the Federal Reserve may be reluctant in raising rates.
One way to decrease the National debt is to grow the economy and increase inflation to pay off the debt with cheaper dollars. It is becoming obvious the Federal Reserve cannot grow the economy with low rates. Another avenue the Government is pursuing is massive tax reform with the belief that it will spur growth giving consumers and businesses more money to spend. Again, the strategy is to increase inflation and thereby help lower the National debt. With that scenario, the economy could better support higher interest rates.
Government entitlements and their burden on the economy are rarely discussed due to politics. If the Government officials had to choose to pay entitlements or interest on the debt, they would default on the debt. With such a large National debt along with the Government's enormous entitlement obligations, the Federal Reserve will likely avoid higher interest rates in the near term so as not to magnify the problem.
Barring a terrorist attack or a national disaster, I believe interest rates should not materially increase until there is further strengthening of the global and US economies.
As for the local economy, residential real estate inventory is extremely low, evidence there still is not enough housing to meet demand. Housing prices continue to rise, commercial vacancy rates on all product types are down from last year, and unemployment is the lowest it has been for a decade. In combination, this makes for a stable local economy in the near term.
In conclusion, I believe there is still some steam left in this business cycle, and the low-interest rates we have become accustomed to over the last several years should not be changing dramatically in the near future.
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