Central Banks May Face Race To Hike Interest Rates

Central Banks May Face Race To Hike Interest Rates

http://www.cnbc.com/id/34844548?__source=RSS*tag*&par=RSS

Source: CNBC

Federal deficit in the danger zone

Time is running out for attacking the deficit. The danger, once distant, is now close. Soaring deficits are jacking up the national debt, resulting in higher interest rates and raising the odds of an even weaker dollar, which would stunt economic growth and lower Americans’ future standard of living.

Spending is out of control. For years it has averaged about 20% of GDP. This year, it’ll be about 25%. Some of that is due to spending on war in the Middle East as well as efforts to cushion the effects of the recession through higher unemployment benefits, aid to banks and state governments, spending on roads and highways, and more. Plus, tax receipts diminished as the economy shrank.

But even after the economy fully recovers, outlays won’t ebb. The growing ranks of retirees mean that Medicare and Medicaid costs will keep soaring, even if health care reform successfully curbs increases in the cost of care -- an iffy proposition at best.

Such entitlement programs -- those that lawmakers don’t control on a year-to-year basis but that run on a sort of autopilot -- account for 54% of federal spending. And they’ve climbed 6.4% on average a year since 2000. When it comes to spending that it can control annually, Congress has shown little restraint. Discretionary spending, which includes defense and an array of domestic programs from national parks to the FBI, has risen over the past decade at an average of 7.5% a year.

The result is an annual deficit that in fiscal 2009 was equal to nearly 10% of GDP, the largest since it hit 21.5% in 1945 at the end of World War II. What’s worse is that a mountain of debt will continue to pile up even if the politicians in Washington manage to keep a rein on spending and trim the yearly deficit. In fiscal 2009, federal debt held by the public jumped by a third, to $7.8 trillion. At the end of fiscal 2008, debt held by the public measured 41% of GDP. By 2014, it’ll equal a whopping two-thirds of GDP.

The interest payments on the debt will be staggering. They could soar to as much as $800 billion a year by the end of this decade, gobbling up 16% of the total budget. Indeed, servicing the debt may become the single biggest item in the federal budget, surpassing Medicare, defense and Social Security.

That will raise the cost of borrowing for everyone -- households and businesses alike. And it threatens to derail the U.S. economic engine. A jump in the debt from 40% of GDP to 60% would boost the rate on Treasury bonds by a full percentage point. Other interest rates, such as those for mortgages and corporate bonds, would follow. And if the U.S. loses its top credit rating -- until recently, an unimaginable event -- interest rates will increase even more. China, Saudi Arabia and other cash-rich nations would insist on higher returns to keep buying U.S. Treasuries at auctions.

Foreign nations, which own about half of the $7.8 trillion public debt, don’t need to sell to make waves. They could simply slow their rate of buying. That might tempt the Federal Reserve to buy debt in order to stave off a rise in interest rates. But that’s no way out. “Countries have tried that and seen double-digit inflation,” says Rudy Penner, former director of the Congressional Budget Office, now with the Urban Institute. “Even the tiniest probability of that has to be avoided.”

There are no easy fixes. Diane Swonk, chief economist with Mesirow Financial, says, “We’re going to have to cut overall spending and raise overall taxes.” In fact, solving the problem will take unparalleled restraint, and determination by elected officials of all stripes.

The US dollar and looming interest rate risk

Just two months ago, economists were predicting a protracted fall in the strength of the US dollar. But since then, the the fundamental and technical evidence points to a rebounding U.S. dollar, at least in the short term. This is significant because continued demand for the relative safety of US Treasuries could mean interest rates should remain on the low side for the foreseeable future. Maybe six months.

No alternatives - flight to safety

If the US economy was isolated from the rest of the world, US government (record deficit-spending) policy responses to the financial crisis should send the dollar into a free-fall. But economic problems are global and threaten the sustainability of a global recovery. That makes investors nervous, and when they’re nervous, they prefer to own US dollars. Global investors responded to the uncertainty by plowing money into the U.S. Treasury market. Currency values are determined as compared to the value of other currencies. With that in mind, the dollar is positioned to strengthen. However, at the risk of stating the obvious, things could change rather quickly once the global economy improves.

A January 2010 Bloomberg poll indicates of how quickly perception can shift. According to the poll, investors have turned bullish on the U.S., a stark contrast from the views just a quarter ago. It turns out the rest of the world is in poor economic shape. Comparatively speaking, the U.S. and the dollar appear stronger for the time being.

Interest Rates

Granted, there is no clear correlation between US dollar and nominal interest rates. But as long as there is demand, Treasury rates, which affect mortgage and other borrowing rates, probably won't need to rise as quickly in order to attract investors. That said, record deficits harbor the risk of inflationary pressures. Higher rates inevitably follow.

If you held a gun to my head and forced me to make a prediction, I'd say Treasury rates should stay steady for about six months before beginning a prolonged rise. This gives financial institutions a small window of opportunity to get their balance sheets in order. Interest rate risk looms as the next major hazard to their bottom line, as well as to the US banking system.

Tom Dluzen

Do bankers have good points opposing credit union increase in business lending cap?

Bankers oppose increase in business lending cap. Do they have a good point?

Read their letter to the US Senate

Also see: Per examiners, commercial property is the biggest risk below

Commercial Property Is Biggest Risk, U.S. Bank Examiners Find

By Craig Torres
Jan. 6 (Bloomberg) -- Losses on commercial real estate loans pose the biggest risk to U.S. banks this year, troubling smaller lenders while unlikely to threaten the entire financial system, U.S. bank examiners concluded during a review.
“Losses from commercial real estate will be quite high by historic standards,” said Eugene Ludwig, former Comptroller of the Currency who is now chairman of Promontory Financial Group, a Washington-based consulting firm to financial institutions. “Hundreds of banks will fail or will be resolved over the course of the cycle.”
Federal Reserve Governor Elizabeth Duke said in a Jan. 4 speech that credit conditions in commercial real estate “are particularly strained.” Fed Governor Daniel Tarullo cited commercial real estate as one of the “key trouble spots” in congressional testimony in October after the Fed stepped up a review of banks’ exposure to such loans.
The failure of loans backing malls, hotels and apartments may impede the U.S. recovery as small- and medium-sized banks reduce lending and conserve capital to absorb losses, analysts said. Tight credit could slow the cycle of investment and hiring that is critical for sustained growth, they said.
Fed Chairman Ben S. Bernanke, in a Dec. 7 speech, cited tight credit among “formidable headwinds” likely to hinder growth. Total loans and leases by banks in the U.S. fell to $6.79 trillion in November from $7.23 trillion in the same month a year earlier, according to Fed data.
More Than Doubled
The default rate on commercial mortgages held by U.S. banks more than doubled to 3.4 percent in the third quarter, according to Real Estate Econometrics LLC, a property research firm in New York. Default rates in the first three quarters of 2009 have been the highest since 1993, according to the firm.
Losses on the debt will “place continued pressure on banks’ earnings” because collateral values have fallen, Jon Greenlee, associate director of the Fed’s bank supervision division, said in Nov. 2 testimony to the domestic policy subcommittee of the House Committee on Oversight and Government Reform.
Banks and investors held about $3.5 trillion of commercial real estate debt in June 2009, with about $1.7 trillion of that total on the books of banks and thrifts, according to Fed data. About $500 billion of the loans will mature each year over the next few years, Fed officials say.
Regional banks are almost four times more concentrated in commercial property loans than the nation’s biggest lenders, according to data compiled by Bloomberg on bailout recipients.
Vulnerability of Banks
Investors have recognized the comparative vulnerability of smaller banks. The KBW Regional Banking Index, which includes shares of Old National Bancorp of Evansville, Indiana and Glacier Bancorp Inc. of Kalispell, Montana, fell 24 percent last year compared with a 3.6 percent decline for the KBW Bank Index, which includes shares of JPMorgan Chase & Co. and Citigroup Inc.
“The strong get stronger and the weak get weaker,” said Joel Conn, president of Lakeshore Capital LLC in Birmingham, Alabama, which specializes in financial stocks. “It is very difficult to come up with a scenario where earnings get anywhere back to normal for small banks with large commercial real estate exposures.”
Fed officials stepped up reviews of commercial real estate loans at banks last year. The Fed is focusing on banks smaller than the 19 largest lenders examined in May. Those institutions held assets exceeding $100 billion.
Defaults among prime borrowers for residential mortgages will probably accelerate this year, according to Robert Shiller and Karl Case, the economists who created the S&P/Case-Shiller Home Price Index.
Hold to Plans
Still, the Fed will probably hold to its plans to finish the purchase of $1.43 trillion in mortgage-backed securities and housing-finance debt by March 31, barring a reversal in the economy or big rise in mortgage rates, Fed watchers said.
“Clearly, the market would react quite negatively if the Fed said, ‘We are changing our mind,’” said Stephen Stanley, chief economist at RBS Securities Inc. in Stamford, Connecticut, and a former Richmond Fed researcher.
Bernanke has said the purchases have helped lower mortgage rates and stabilize the economy. The Fed, which began in September to slow down the purchases, still has about $139 billion of mortgage-backed securities left to buy out of $1.25 trillion, and $15 billion of federal agency debt out of $175 billion.
Chris Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi UFJ, Ltd. in New York, said Fed officials will monitor mortgage rates and the difference in yields between mortgage-backed securities and Treasuries.
‘Opposite Direction’
“They will not extend it without seeing a bad outcome,” Rupkey said. “Everything seems to be moving in the opposite direction” of increasing purchases of the securities, he said.
St. Louis Fed President James Bullard said in November that the central bank should retain the flexibility to respond to any weakening in the economy by extending beyond March its authority to buy mortgage-backed securities and agency bonds.
Mortgage rates in the U.S. rose last week to 5.14 percent, the highest since August, Freddie Mac said Dec. 31. That’s still close to the record low of 4.71 percent reached in the week ended Dec. 3 and the average 5.04 percent for 2009. Rates averaged 6.05 percent in 2008 and 6.34 percent in 2007.
An increase in rates to 6 percent may prompt the Fed to reconsider ending purchases of mortgage-backed securities, Rupkey said.

Opinion - Man on the street - Fed Bans Debit Overdraft Fees

The Federal Reserve is prohibiting banks from collecting overdraft fees on purchases paid with a debit card unless customers opt in to programs that guarantee their balance-exceeding transactions go through. What do you think? See some responses

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Yields on the benchmark U.S. 10-year note to rise over the next 6 months

Yields on 10-year notes will end 2010 at 4.14 percent, the highest level since June 2008, according to a Bloomberg News survey. The yield on the benchmark 3.375 percent security due in November 2019 rose 4 basis points on January 13th, 2010. Mortgage rates are likely to follow. Here's the link http://bit.ly/6EWYJp

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Blogger Tom Dluzen interviews Steve Forbes for Credit Union Business Magazine

Steve Forbes, Chairman and CEO of Forbes, Inc., http://www.forbes.com/, took time out of his very busy schedule to speak with me about his views on the economy and how current economic trends might affect the credit union industry. Mr. Forbes touched upon major issues such as interest rates, the credit markets, the U.S. dollar, and proposed “mark-to-market” accounting rule changes.

Interest rates are affected by a myriad of pressures, including inflation, deflation, the relative strength (or weakness) of the U.S. dollar, availability of credit, record deficits, foreign and domestic demand for U.S. Treasurys, to name just a few. Interest rate risk for credit unions is always lurking in the background, but because of the current environment, the threat may be greater than normal. It is a complicated issue, but Steve . . .

Please go to Page 33 of Credit Union Business Magazine to read the entire article.

Congress - yet another swipe at credit cards?

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Congress - another swipe at Credit Cards? Read the WSJ Article http://online.wsj.com/article/SB10001424052748704905704574622722184163510.html?mod=googlenews_wsj

Personal bankruptcies rising fast

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Personal bankruptcies rising fast - Wall Street Journal http://online.wsj.com/article/SB126263231055415303.html?mod=WSJ_hpp_MIDDLTopStories

Higher Jumbo CD rates could foretell the future

This index is the 12 month average of the monthly average yields of 3 month certificates of deposit. In plain English, this index is calculated by averaging the previous 12 rates of the 3 month CD rate. The 3 month CD rate used is the rate publish monthly by the Federal Reserve. Because this particular index is an annual average, it is more steady than straight CD rates. As you can see, rates can move rather quickly over the course of a year.

Anecdotally speaking, I've noticed that over the last month or so, Jumbo rates are moving up. As members gain more confidence in the stock market, there could be more competition for deposits that could precipitate a move towards higher rates overall.