Low Rates Will Work for the Economy

 | Jan 26, 2012 | 1:00 PM EST  | Comments
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uan

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The Federal Reserve said Wednesday interest rates would remain low until 2014, a year longer that was previously estimated. This was a good move. It shows that the Fed is willing to do what it takes to revive the US economy. More so, a continued low-rate environment will slowly but surely boost bank lending.

The doubling up of households -- kids moving back home with parents or couples with in-laws -- can only last so long. At some point the hormones kick in and people want to be independent again. After the Great Recession, the rate of household formation fell off a cliff. According to U.S Census Data, before the housing bubble burst in 2007, 1,627,000 new households were created, topping off a decade average of 1,499,000 new households a year. But in 2010, that figure was down to 357,000, a drop of 78% percent from three years before.

Just as the pre-bubble figure may have been unsustainable, the 2010 housing start figures are unsustainably low. Every year millions of young Americans matriculate from college and most of those people are actually finding jobs. And at some point many of them will become homeowners. As household creation grows, the economy gets a major tailwind as home buyers buy furnishings, hire contractors and the like.

Bloomberg reported Thursday that banks like Wells Fargo (WFC) continue to boost their purchase of investment securities to earn income from idle cash. The continued effect of such low interest rates will eventually spur lending demand. The opportunity to earn a higher yield from a high quality borrower will at some point lead banks into the lending arena. That is the nature of capitalism. An employed college graduate that is a first time home buyer constitutes a quality borrower in my book. As an added bonus, the decline in real estate prices along with historically low interest rates means that housing payments are lower, in some cases significantly lower, than they were three years ago.

On the equity front, it's hard to ignore the significant yields some high-quality issues are paying today. Verizon (VZ) currently yields more than 5% and continues to benefit from the mind blowing surge in iPhone sales. Lesser-known CVR Partners (UAN), a producer of nitrogen fertilizer, yields more than 8%. The real threat of inflation ensures that parking cash in the bank is not a risk-free endeavor. For those that rely on reported numbers to convey the inflation rate, I think it would be more meaningfully to compare utility bills today with those from years back or the price of a dozen eggs, a gallon of milk, or a gallon of gas over the same time period.

So far, lower interest rates have not depleted the appetite of US Treasuries abroad and that isn't likely to change. No debt market is as liquid or efficient as the U.S. for big purchasers like China and Japan. Slowly but surely, the Fed's continued low interest rate will provide the needed stimulant to the economy. It's a not a perfect solution, but one that will ultimately prove most effective.

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