The Federal Reserve May Have To Raise Interest Rates Before 2015

by: Kevin Mahn

While the headline of this commentary may come as a surprise to many, it was the exact sentiment conveyed by Federal Reserve Bank of Philadelphia President Charles Plosser on Tuesday, September 25. The statement runs afoul of the public comments made by Federal Reserve Chairman Ben Bernanke, who recently stated that the Federal Reserve intends to extend its accommodative credit stance (i.e. keep interest rates at historic lows) through the middle of 2015 - at least. In providing the Federal Reserve rationale behind the extension, Bernanke cited a concern with future economic growth without improvements in the labor market. A correlation between job growth and economic growth certainly appears to be evident, as economic growth and job creation have been sluggish during this recovery from the "Great Recession."

According to the Center on Budget and Policy Priorities, the U.S. economy has grown for twelve straight quarters, but the pace of the recovery has been slow and below historical recovery averages. To this end, the economy, as measured by Gross Domestic Product (GDP), grew at an annualized rate of just 1.7% during the second quarter.

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Source: U.S. Department of Commerce, Bureau of Economic Analysis, September 2012

On the jobs front, again according to the Center on Budget and Policy Priorities, the private sector has created an average of approximately 154,000 jobs a month for the past 30 month time period, though the national unemployment rate remains above 8%. However, it is estimated that an average of 195,000 new jobs would need to be created each month, for the next two years, to return to where employment levels stood in December of 2007, before the Great Recession began.

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Source: Bureau of Labor Statistics, U.S. Department of Labor, September 2012

However, the question remains if a longer, more accommodative stance towards credit by the Federal Reserve will help to spur more job creations and jump start the economy - or vice-versa. Philadelphia Fed President Plosser does not seem to think so and believes that the Fed may need to raise interest rates sooner than 2015 if the economy starts to grow at a faster rate than the grinding pace that the Fed is currently forecasting. According to the Wall Street Journal in a September 25, 2012 article, entitled, "Fed's Plosser: Fed Will Have to Tighten Before 2015," Plosser also stated that the Fed's recent round of bond buying, in particular, is risky as it could place even more inflationary pressures into an economy that already has absorbed significant rounds of stimulus spending. While it should be noted that while Plosser is not a voting member of the Federal Open Market Committee, his comments should nonetheless be disregarded given his position and experience.

This much is clear to us at Hennion & Walsh: nobody has a crystal ball, and trying to predict changes in interest rates is often an exercise in futility, as there are so many factors that are now involved in interest rate policy decision making within our globally interconnected economy. This does not necessarily mean that investors should stand idle waiting for announced changes in interest rates. Rather, in my opinion, investors with a primary objective of income should continue to look for income producing strategies that attempt to maximize income potential in a given market environment consistent with their tolerance for risk and investment timeframe. Such income producing strategies may include bonds, dividend paying equities, mutual funds, closed-end funds, exchange-traded funds (ETFs) and unit investment trusts (UITs), to name a few.

When reviewing these various income producing strategies, I would recommend not only focusing on current yield information, but also taking into consideration longer term distribution histories, credit quality, tax treatments and distribution policies. It is fair to say that all distributions/dividends are not created equal and should be researched and understood accordingly.

Disclosure: Hennion & Walsh is the sponsor of the SmartTrust® Unit Investment Trusts (UITs).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.