Tag Archives: Interest rate

Updates from Chicago Booth

Why central banks need to change their message
The US and European central banks thought they could manage their economies by bringing their secretive plans for interest-rate regulation into the light. But they didn’t account for an unreceptive public.
By Dee Gill – A lot of people don’t have a clue what central banks do, much less how the institutions’ ever-changing interest-rate targets ought to affect their household financial decisions. Recent studies, including several by Chicago Booth researchers, find Americans and Europeans oblivious to or indifferent to the targets’ implications.

This is a serious problem for policy makers. For a decade, monetary policy in many developed economies has relied heavily on forward guidance, a policy of broadcasting interest-rate targets that works only if the public knows and cares what its central bankers say.

“The effects of monetary policy on the economy today depend importantly not only on current policy actions, but also on the public’s expectation of how policy will evolve,” said Ben Bernanke, then chairman of the US Federal Reserve, in a speech to the National Economists Club in 2013. At critical times since 2008, forward guidance has been the Fed’s and the European Central Bank’s go-to tool for revitalizing their ailing economies and holding off widespread depression.

Forward guidance usually involves central banks announcing their plans for interest rates, which traditionally were guarded as state secrets. The openness is intended to spur investors, businesses, and households to make spending and savings decisions that will bolster the economy; typically, to spend more money during economic slowdowns and to save more when the economy is expanding.

Chicago Booth’s Michael Weber and his research colleagues, in several studies, tested the basic assumption that households will respond to forward guidance, and find it flawed. Most people, the researchers conclude, generally do not make spending and savings choices on the basis of inflation expectations. In personal financial decisions—for example, to pay or borrow money for a boat, refrigerator, or renovations, or to sock away funds for rainy days—words from central bankers hardly register. more>

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Updates from Chicago Booth

How to make money on Fed announcements—with less risk
By Dee Gill – Andreas Neuhierl and Michael Weber find gains of about 4.5 percent when investors bought or shorted markets in the roughly 40 days before and after Federal Open Market Committee (FOMC) announcements that ran counter to market expectations. Investors can make money on these “surprises,” even if they did not take positions before the announcements, the findings suggest.

Markets routinely forecast the content of FOMC announcements, which reveal the Fed’s new target interest rates, and usually react when the Fed does not act as expected. An FOMC announcement is an expansionary surprise when its new target rate is lower than the market forecasts and contractionary when it’s higher than expectations.

Share prices moved predictably ahead of and following both types of surprises, the study notes. Prices began to rise about 25 days ahead of an expansionary surprise, for about a 2.5 percent gain during that time. Before a contractionary surprise, prices generally fell. The researchers find that the movements occured in all industries except mining, where contractionary surprises tended to push share prices higher. more>

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What Keeps the Rich and Powerful up at Night, and Why They’re Happy You Don’t Care

By Tom Streithorst – So a primer.

Knowing how interest rates function will immeasurably improve your understanding of how the world actually works. Bankers and economists spend their life studying this stuff, so to make it comprehensible for civilian readers I’ll have to simplify a bit and leave some things out. Nonetheless, the essence is pretty straightforward. Sadly, economics is one of those subjects where boredom is a signifier of seriousness. That’s to keep the hoi polloi from knowing the secrets inside the temple. I’ll strive to keep this both entertaining and informative. Okay, here goes.

Interest rates are the price of money so changes in rates affect just about everything else in the economy. They connect the present with the future, and remain the most powerful tool policy makers have to control unemployment, inflation and economic growth. The ramifications of interest rate changes can also have vast political effects.

Everything from Britain’s victory in the Napoleonic Wars to the success of Reagan and Thatcher can be explained through the prism of interest rates.

Had Napoleon been able to borrow as cheaply as Britain, he probably would have never had to fight the battle of Waterloo.

The business sections of newspapers obsess about interest rates because knowing their future path is a guaranteed way to make money. Traders think of little else. That’s because interest rates affect the price of just about everything from gold to shares to bonds to houses.

An interest rate cut will increase the value almost all assets. A rate hike, on the other hand knocks down the price of everything from houses to bonds to shares.

But wait. If you have been paying any attention to the global economy since the financial crisis, you’ve noticed a tragic flaw in my argument. I’ve been banging on about how interest rate cuts stimulate the economy and yet, for the past eight years we have had the lowest interest rates since Babylonian times and the economy still staggers along disappointingly. more> http://goo.gl/2kqNHH

The simple rule at the heart of finance is being broken

By Matt Phillips – If you lend somebody money, they have to pay you back with interest.

This is the basic premise of all finance, from street corner loan sharks to Wall Street loan sharks.

No longer. With central banks pushing the limits of their ability to stoke growth, interest rates on many bonds are in negative territory, effectively turning the core rule of finance on its head. When investors buy bonds with negative interest rates, they’re agreeing to pay a borrower to take their money.

On the face of it, paying someone to borrow your money seems like a bad idea. But it isn’t, necessarily … more> http://goo.gl/PB4ae6

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Fed Refrains From QE Taper, Keeps Bond Buying at $85 Bln

By Joshua Zumbrun & Jeff Kearns – “Conditions in the job market today are still far from what all of us would like to see,” Chairman Ben S. Bernanke said at a press conference today in Washington after a two-day meeting of the Federal Open Market Committee. “The committee has concern that rapid tightening of financial conditions in recent months would have the effect of slowing growth.”

Bernanke added in his press conference that the first interest-rate increase may not come until the jobless rate is “considerably below” 6.5 percent. more> http://tinyurl.com/pver49a

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The Strange Business of Central Banking

By Matthew C. Klein – Central banking is a weird business: Small groups of unelected officials affect the fates of billions. One particular concern is that policies meant to benefit everyone might help some more than others.

Interest rates come in many flavors depending on who is trying to borrow from whom. A small business in need of working capital isn’t exposed to the same set of interest rates as a prime mortgage borrower or a large technology company or the U.S. government. There is no reason to think that measures that are supposed to lower rates for one of those entities would have any significant impact on the others.

This is a serious problem because businesses with fewer than 20 employees create (pdf) the most jobs. more> http://tinyurl.com/mlfnnjd

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Ben Bernanke’s legacy: The looming contraction he only delayed

By Charles Ortel – Not long ago, esteemed market observers seemed certain the world entered a new era where the cost of borrowing and the returns available to equity investors would remain far lower than historical experience.

The party seems to be over–interest rates have been rising in 2013 and borrowers across all sectors of the American economy are about to discover the hard way what happens when “real” interest rates jump closer to levels seen over the full course of a business cycle.

  • Truth # 1: Inflation is Rising which means that the Cost of Servicing America’s Existing Debt Balances will also Rise
  • Truth # 2: Americans have Run out of Room to Borrow More Money–We Soon will have to Reduce our Debt Balances
  • Truth # 3: Americans do not have Unlimited Stores of Asset-Based Collateral that Readily Can be used to Reduce Debt
  • Truth # 4: America’s Debt Balance seems far too High in Relation to Total Private Sector Incomes
  • Truth #5: The Unusual Composition of America’s Population Will Continue to Depress Incomes and Demand for Decades

more> http://tinyurl.com/oneo55h

Bonds: How to Play Interest Rate Peril

Federal Funds Rate (effective)

Image via Wikipedia

By David Bogoslaw – Interest rates can turn quickly, as the Greek government learned when its 10-year bond soared more than 9 percentage points in the past year on default worries.

Owen Murray, director of investments, expects interest rates to rise sooner, due to bond investors’ insistence on being paid more for the money they’re lending than because of policy changes by the Federal Reserve. The wake-up call for bond investors, he says, could come in March 2012 if they see equity fund managers report returns of as much as 30 percent a year since the March 2009 lows. That would make them see how much money they have given up by sticking with low-yielding bond portfolios. more> http://is.gd/LKdudf