2 reasons the Fed may keep interest rates at zero

Janet Yellen has flagged 2 risks to the US economy that could delay higher rates: the housing market and the fragile condition of foreign economies.

By MSN Money Partner May 9, 2014 6:07PM
Caption: Federal Reserve Chair Janet Yellen
Credit: © Cliff Owen/APBy Rex Nutting, MarketWatch

Everyone assumes the Federal Reserve will finally raise interest rates sometime next year.


That's what the Fed's "dot plot" is forecasting, that's what the markets are pricing in, and that's what almost every Fed watcher believes.

But what if they are wrong? What if the Fed delays that first rate hike? What if the U.S. economy isn’t ready for higher rates in 2015?

In her testimony to Congress this week, Fed Chair Janet Yellen (pictured) didn't steer anyone away from the assumption that the Fed will probably raise rates next year. But she did flag two risks to the economy that could delay higher rates: the U.S. housing market and the fragile condition of foreign economies.

The link between a weak housing market and low rates is pretty straightforward: Housing is very sensitive to interest rates. Usually, the Fed's easy-money policies work primarily through the housing market. By lowering borrowing costs for home buyers and home builders, the Fed can accelerate home buying and home building, and give the economy a jump-start that spreads to other sectors of the economy.

This channel for monetary policy has failed in this expansion, mostly because a warped housing market was the main cause of the recession, and it’s taking time to fix it. Many families can't buy a house, either because their credit was ruined by a foreclosure, or because they are underwater on their current mortgage, or because they want to further reduce their debts, or because their income growth won't allow it, or because lenders are reluctant to lend to any but the most overqualified buyers.

During last year's "taper tantrum" in the bond market, just the hint of tighter monetary policy put the brakes on the housing recovery, as mortgage rates drifted higher. By almost every metric, housing has slowed in the past six months, and the Fed is as much to blame for that as anyone.

It's possible that the housing market will be strong enough by next year that it could accommodate higher rates. But it's also possible that housing will remain so weak that even a whisper of higher rates could crash the market. The Fed doesn't want to do that.

The link between interest rates in the U.S. and fragile foreign economies isn't so simple.

Typically, the Fed hasn't worried too much about the impact of its policies on foreign economies. The feeling has always been that, if the Fed's low-rates policies spark capital flows into emerging markets, that's a problem for their central banks, not ours.

And if raising rates causes capital flight and destabilizes those countries, that's unfortunate. But that wouldn't stop the Fed from doing what it thinks is best for the U.S. economy.

But the Fed may have to pay more attention to global risks going forward. Not because the Fed is suddenly feeling charitable, but because the U.S. economy is more vulnerable to a global slowdown. Exports are a rising share of U.S. gross domestic product, which means more of our growth comes from overseas markets. And the financial links between the U.S. economy and foreign economies are getting stronger and more opaque.

The next global slowdown could be a whopper. Emerging markets, which now account for nearly half of global GDP, have fueled their growth by expanding their balance sheets with private-sector debt. And the chickens are coming home to roost, says economist David Levy of the Jerome Levy Forecasting Center.

Levy, who made a killing off his early prediction in the last decade that the U.S. housing bubble would implode, is now predicting that the emerging markets credit bubble will do the same, with disastrous consequences for them and for us. He believes the emerging markets recession will begin within the next six to 24 months.

And that means the Fed will be forced to keep short-term rates near zero for the rest of this decade.

"The deflationary and severe nature of the next global recession will lead to a long, troubled aftermath during which the Fed will not entertain the thought of lifting rates off the floor," Levy wrote in his monthly report to clients.

Levy's dire forecast isn’t shared by many other economists. His forecasting methods are specifically attuned to financial flows, which gave him a big advantage when it came to forecasting the 2008 catastrophe. Other forecasters were blasé about the credit bubble because their economic models didn’t take notice of financial imbalances.

The Fed certainly doesn’t agree with Levy that a global recession is looming. But Yellen and her army of economists aren't blind to their model's blind spots. They were burned pretty badly in 2007 and 2008 when the housing bubble burst. They know that unforeseen events can have nasty consequences.

And that's why Yellen warned this week that global imbalances are a genuine risk to the U.S. economy. And that's why the Fed will continue to walk on eggshells.

More from MarketWatch

May 9, 2014 8:27PM
The Fed has no option but to keep interest rates at zero to encourage borrowing and spending in order to keep the house of cards charade up and running. It cannot afford anything over that. The trade deficit continues to widen, there's no savings and there is no real productivity. The government would default on the debt with any interest rates above 4% because there isn't enough tax base to cover the sheer interest on 18 trillion. It has to continue QE infinity by monetizing debt into money. The Fed's plan is trying to create inflation in order to vaporize debt and devalue the currency to make exports cheaper. Diocletian did the same thing during the last days of the Roman empire before collapse. This is what happens when markets are distorted through central planning and years of government over spending, abuse and intervention. The day of reckoning is near. When? Who knows, but all the signs from history are all there.
May 10, 2014 9:45AM
the third reason: redistribute wealth to wall st
May 9, 2014 9:54PM

Because if they don't the oberry economy goes in the dumpster!

May 11, 2014 10:57AM

Funny why no one ever mentions the real reason for low rates; the financing of our colossal debt. Currently we spend less on interest payments now than we did 7 years ago despite more than twice the debt. IF short term interest rates were to rise too quickly, treasury rates would double(or more), leading us, as Ex Deo stated, to a situation where we simply would not have enough tax revenue to cover higher interest rates, let alone rung the government.

That said, I still believe we are on the cusp of a major growth cycle IF Congress and the President act like they have some common sense instead of constantly putting ideology ahead of duty, and if the democrats stop acting like higher taxes are the answer to everything.

May 10, 2014 7:04PM
This Fed cabal will continue propping up the economy with with low interest rates and money printing until market forces take that ability away from them.  It will probably start with another financial crisis of unknown origin that will blindside them.  It could be a strong move away from the dollar as the major world currency instigated by China and Russia.  Couldn't blame them for doing it based on our irresponsible economic policies that don't seem to give a rat's **** about their effects on the rest of the world's economies.  At this point our economy is definitely a house of cards......just don't know what's going to bring it down or when.  The Fed has juiced it as much as they can and the results have been minimal.  When interest rates start climbing the housing market will stumble.  One good kick and the whole rotten system will start to collapse.
May 11, 2014 4:41AM
The Global FEDS are making a assumption that even after Global Debt has Soared 40% since the Great Recession, they can still be Godlike in their Control of where interest rates continue to go. There are more then a couple of smart folks that think otherwise.

The Guys that write these type of Articles Yap on and on about everything but what actually caused the FED to lower Rates, the Global Derivative Scam Markets. Yep, funny how during the Great Recession, that's all folks could talk about. Today, the Main Stream Media Talking Heads including this one is quiet as a Mouse about it. You can go to the Cleveland Fed site and see the Entire Scope of the Problem along with countless others. Yet so many folks want to ignore and the reasons why should be clear to all. That problem was never fixed and only delayed for a future Date. However.

Fannie will pay a dividend of $5.7 billion to the U.S. Treasury next month. With its previous payments totaling about $121 billion, Fannie has more than fully repaid the $116 billion it received from taxpayers.

Freddie Mac posted net income of $4 billion for the first quarter. Freddie, based in McLean, Virginia, will pay a dividend of $4.5 billion to the government. Freddie already had repaid its full government bailout of $71.3 billion after paying its third-quarter 2013 dividend.

Corporations and State/Federal Governments were basically given a chance to shore up their Balance Sheets via the Global Feds lower interest Rate Polices. Instead of committing to more Cap X spending to shore up their future, most companies have committed to accelerating the ongoing massive transfer of wealth from the actual Workers to instead the top 1% parasite class.

So this is the expected result, we now have far more Consumers who are working harder and being far more Productive yet most don't have a viable Wage to buy products from the Global Corporations which have committed far more to Top Shareholders then to their own workers. They also can't buy homes in enough numbers. Therefore It's a viscous cycle that can only have one ending if this insanity is allowed to continue.

May 11, 2014 12:13PM
   Why don't the fed give me some a that interest free money?
May 11, 2014 4:25AM
"Janet Yellen has flagged 2 risks to the US economy that could delay higher rates: the housing market and the fragile condition of foreign economies."

Does anyone trust anything that comes out of Aunt Yellen's mouth? The only thing this witch is concerned about, keeping the Stock Market moving Higher. Literally everything else has little meaning to these elitists types.

"Emerging markets, which now account for nearly half of global GDP, have fueled their growth by expanding their balance sheets with private-sector debt."

David, you better check the Balance sheets of non-emerging markets, they are doing the same but on a Far larger Scale. How do folks like you get paid for these misleading statements?

"The link between a weak housing market and low rates is pretty straightforward: Housing is very sensitive to interest rates."

Funny how folks were able to buy homes at much Higher Rates long before all this BS started with Big Banks giving out Loans to Customers they knew couldn't afford them. The biggest Problem has been the massive Transfer of Wealth from the Working Poor and Fading Middle-Class to the Already Wealthy. The Wage Gap which was once 40 to 1 has moved to well over 400 to 1. A massive transfer of Wealth from the 99% whom have created the most Production to the 1% whom have created the least, that is the Root of the Housing Problem.

May 10, 2014 11:43AM

Active you are making me think to much....

I would rather be at a Casino...(today they give away some free gifts, Sheet and pillow sets, telescopes or Foreman grills).

Or on the Deck drinking some Sweet Lucy...(later tonight)

May 11, 2014 7:26PM
Kenndog says, "Funny why no one ever mentions the real reason for low rates; the financing of our colossal debt. Currently we spend less on interest payments now than we did 7 years ago despite more than twice the debt"

Actual Ken, that's the most obvious reason and has been spoken about many times by posters on these posting boards. What you fail to mention however, this hardly just an American Problem, it's a Global Problem which is why the Global Feds have Collude together to manipulate rates. Just take a look at Global Rates and Global Debt, Rates should be Far higher. When I stated Global Debt has risen 40% since the Great Recession, just what the heck do you think I was talking about.

Government Debt is a huge problem Globally but unfortunately there is an even Bigger Problem, Derivative Scam Debt Obligations created by corrupt banks to the tune of $500-700Trillion Dollars. That Dwarfs the Debt issues of all other types of Debts Globally combined including Mortgages. That was and still is the primary Reason for the Global Feds lowering Rates. Interest Payments on the Debt was also a Major issue.

Corporations are spending nearly anywhere from a 1l2 to 3/4 Trillion each Year on Stock Buybacks and Dividend payouts. That's a major byproduct of the Global Collusion on Interest Rates. If interest rates rise quickly at some point, it won't be just the United States at Risk. Literally every Major Economy is subject to that same Risk of rising Rates and the ability to pay off Huge Debt Interest. Japan's Debt issue is far worse then ours. China is a Black Box.

Higher Taxes across the Board isn't the answer but raising Taxes on those that Benefited the most from the Global Feds continually manipulation of Interest Rates merits attention. That cost alone for us is already to the tune of a Fed Balance sheet way over $4Trillion. It's so easy to point fingers at one Party to gain Political Points when in FACT both parties are to Blame.
May 12, 2014 8:37AM

One the economy hasn't recovered after five years plus because we have such great leadership.

Two the great one is telling them CMA my legacy can't fail.

May 12, 2014 10:04AM


Thanks for re-posting the biggest part of my idea, or take on the NAFTA discussion.

I am not able to cut and paste well..

Active RIA.....TAKE NOTE, of the S&P up within about 8 points of closing in on the 1900 mark.

May 12, 2014 1:42PM
"BARRY" used to go by the "handle:
Dr. Dubury Midung, M.D.
Pretty queer !
May 12, 2014 9:59AM
Approving Nafta and the Repeal of Glass Steagall all tie into where we are now and the QE to infinity. That alone with many others issues spoken about on these Boards countless times.
May 12, 2014 3:39PM
Are all these kids in the same Sophomore Computer class 101.....??
May 12, 2014 1:05PM
Ken states, "Liberals controlled both Houses of the 103rd Congress, 57-43 in the Senate and 258-176 in the House. So you see, Dave, the Democrats could have killed this bill at anytime and the Republicans could have done nothing to revive it."

Ken, what part of more Republicans voted for NAFTA then Democrats don't you understand? What part does MG not understand that Clinton couldn't have signed it if More Republicans voted against the Bill then Democrats?

Folks like MG and Ken can't perform simple Math but they want everyone to think they know a lick about the how the American and Global Economies Work. Clinton Signed the Bill but Republicans who voted 50 plus times to Repeal the ACA had Zero problems in making sure the NAFTA bill had plenty of votes to pass. In both House and Senate, the NAFTA bill received more Votes from Republicans in spite of the FACT that Democrats had more Votes available from either House or Senate.
May 14, 2014 7:39PM
I remember the days when interest rates were up and those of us who saved money, had money in the bank or investments were making money.  Now it sucks!  I am unsympathetic to those who did not save their money for retirement, has not paid off their mortgage and who lived beyond their means.   Boo-hoo!  Bring back the higher interest rates so we can make some money on our investments and retirement!  Thanks a lot for nothing.
May 14, 2014 11:13AM
Obama's economic policies are coming home to roost!  Clearly we're headed for a global economic meltdown that will be followed by the outbreak of WW-III.  Enjoy it now while you can, there won't me many of us left when it's over!  A few remote tribesmen at best.  Someday thousands of years from now they'll be digging up the ruins of our civilization and wondering what happened to us just like we puzzle over the great civilizations of the past today.
May 12, 2014 6:04PM
We get nothing now for anything we could put in banks. No matter how much a person could save. Not like it was around thirty years ago. Things were a lot cheaper to buy anything, with around 5.5% interest. Money market was all the way up to 16% at one time. Then you could slowely get ahead if saved. Now banks lend to the rich, the only ones that can get a loan with our money. We get zip. Now you know why things don't work out anymore. While prices just keep climing to make everything even worse. And they call that economics !
May 12, 2014 9:55AM
Re-Tog posted,

"After becoming a Treaty or Law.....We all saw what happened, and how American Industrialist took advantage of the situation; That they helped create....

Funny how Ross Perot, as an Independent was mainly the only one to throw up the Red Flags, with his...."The giant sucking sound" of Jobs leaving the U.S.

Once NAFTA was in place....Look at the "amazing speed or progression" of how our workforce changed and "out sourcing or off-shoring" was accomplished...

To blame this on a handful of Political Figures or Leaders, is almost comical; When all we or you should have to do is only "pull back the curtain", To see who was "pulling the strings." 

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