When was the last time interest rates were a topic of discussion regarding the U.S. economy? It was probably in 2007 or 2008 when the financial crisis was just emerging. But the recent rise in rates shouldn’t be a cause for undue concern. In fact, it signals that the economy is in much better shape.
That’s not to say that the interest rate policies of the Federal Reserve have not been in the news over the past five years. The Fed has been at the forefront of trying to hold interest rates down, using a variety of old and new techniques to push short- and long-term interest rates down and hold them down. But that’s the point. Over the past five to six years the only driving focus of interest rate policy in the U.S. has been to hold down all interest rates as much and as long as possible. Chief among these new techniques has been the outright purchases of long-term bonds. Now, for the first time since 2007, the Fed is discussing openly the need to allow interest rates to rise.
It hasn’t been an easy or smooth transition for the financial markets. In April/May 2013 the yield on the 10-Year Treasury note was about 1.65 percent and had been sitting between 1.5 percent and 2.0 percent for roughly a year. Then, in May, Fed Chairman Ben Bernanke, in his testimony before Congress mentioned the possibility that the Central Bank might in the future slowly reduce its purchases of government bonds. This policy shift from steady purchases of bonds to gradually reducing the amount of bonds being purchased has been dubbed “tapering” in the media. The mere mention of the Fed considering tapering was enough to send interest rates up sharply. By June the 10-Year Treasury note yield had climbed to 3.0 percent and it has hovered around there ever since.
However, over the past six months, the realization of what tapering really means has begun to sink in. The economy is doing better and the outlook for the next 12 months is for further substantial improvement. That’s the reason the Fed can allow interest rates to rise. In December, the Federal Open Market Committee (FOMC, the policy making committee at the Fed) announced that the amount of bonds being purchased every month would be reduced starting in January 2014. We are now living in a world in which monetary policy is gradually returning to normal after five-plus years of extraordinary monetary stimulus. And it’s happening because the economy is in much better shape than it has been in quite some time. The fact that the Fed is tightening is good news for the economy and good news for real estate markets. The pace of economic growth is finally returning to a normal range and the Fed is returning to its normal role in that economy.