Fed Bigwig: Raise Rates By Summer's End

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There seems to be a groundswell of support for raising interest rates sooner rather than later — and one of the Federal Reserve’s own bigwigs is leading the charge.

That’s the message coming out of the Federal Reserve Bank of Kansas City this week, where director Thomas Hoenig has gone out on a limb — at least inside the Federal Reserve — in calling for a short-term rate hike to 1%. The Fed’s short-term benchmark rate is at 0.25% right now.

A rate hike would be manna from heaven for bank savings investors. Right now, the average national certificate of deposit rate on six-month CD’s, as measured by the BankingMyWay Weekly CD Rate Tracker, is a measly 0.492%.

Savings rates aren’t any better. The BankingMyWay National Savings Rate Tracker pegs the national average for bank savings rates at 0.214%.

Any uptick in interest rates would no doubt raise bank deposit rates, as well — a scenario that would please bank rate investors who have taken a pounding, return-wise, in the bank deposit marketplace over the past 18 months or so.

Hoenig let the cat out of the bag at a speech earlier this week in Bartlesville, Okla., when he said the Fed should “be prepared to raise” benchmark rates to 1% by Labor Day. He also called for ending the “extended commitment” to near-zero-based interest rates, a bedrock platform for the Fed during the Great Recession. The Federal Reserve is keeping rates that low to spur credit and spending — with mixed results to date.

Honeig is a bit of a maverick at the Federal Reserve — his has been the only dissenting opinion in favor of higher interest rates at the past three Fed meetings. But this time he has some tepid support from his Atlanta Federal Reserve Bank counterpart, Dennis Lockhart, who said this week that “the time is approaching” for higher rates, even if “unacceptable levels of unemployment” continue to slow economic growth.

That’s certainly the case now, as the U.S. Labor Dept. reported this morning that only 41,000 private sector jobs were added to the U.S. economy in May — a paltry number given the many economists and politicians who have assured Americans that an economic recovery is underway.

Even as most economists predict that the Fed will hold off on raising interest rates to later in the year or well into 2011 — Bank of America (Stock Quote: BAC) analysts peg the next rate hike for August 2011 — Hoenig is saying that the future is now. Telling his Oklahoma audience that low interest rates have had a “high cost” in the past, Hoenig said the need to balance economic growth without creating another credit bubble requires aggressive action on rates. "We are attempting to support an economic recovery, but in doing so, also avoid fostering the next crisis," Hoenig said.

How aggressive is Hoenig long-term? Very aggressive. He’s calling for a brief pause after the proposed August rate hike, then another increase to 3%, followed by a final hike to 4.5% — which is where Hoenig thinks the Fed should ultimately take the benchmark rate in its long-term policy.

"I have no illusions about the challenges of moving away from zero. But in my judgment, the process should begin sooner to avoid the danger of having to overcompensate later," he added. He also thinks the fledgling economic recovery won’t be battered by any rate hikes.

“More recent data suggest that the recovery is more broad-based and self-sustaining, and perhaps even stronger than anticipated," Hoenig said.

The smart Wall Street money says that Hoenig won’t get his wish. According to futures trading tied to Federal Reserve rates, traders see a 73% probability that the Fed will leave rates right where they are come the Sept. 21 meeting.

That said, Hoenig might eventually succeed in inching the Fed to the brink. In his way of thinking, higher rates are a “sooner” rather than “later” proposition.

Bank savers can only hope he’s right.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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