The Federal Reserve Wednesday announced its latest effort to spur economic growth: a plan to purchase up to $600 billion of government bonds through June 2011. The Fed, as it is called, is trying to lower interest rates, in the hopes that doing so will loosen the supply of credit and spur more economic activity. The central bank’s main tool for reducing rates is to slash the short-term overnight lending rate that banks charge to one another, the so-called Federal Funds rate. Bring short-term rates down, and long-term rates tend to follow. In normal times, that’s as far as the Fed usually goes. In the past three years, the Fed has reduced the Fed Funds target rate 10 times, from 5.25 percent to between zero and .25 percent. It’s been at that extremely low level since the fall of 2008. This is one of the reasons we have seen such amazing rates during the last couple years and why they have remained low.
BUT- that does not mean that VA interest rates will go lower. In fact, if anything they have reached levels that they can’t break through going lower, with inflation and such.
Investors love to repeat the mantra: Don’t fight the Fed. Also with as much firepower as the central bank possesses, the Fed isn’t the only dominant economic power in the world. And interest rates can be impacted by all sorts of factors. If China’s central bank cuts back sharply on its purchases of U.S. government bonds, which they could do at any time, interest rates will rise. Investors’ attitudes about the pace of growth, or inflation, play an important role in determining market interest rates also. And where we have seen rates low for such a long time, more of the same seems unlikely.
Moreover, what does the Fed believe it will gain by adding more and more government bonds to it balance sheet? That is the question isn’t it? There are a couple of risks. First, low-interest rates and the expansion of the Fed’s balance sheet tend to weaken the dollar. But the second and larger risk is that the dollar will not weaken. Interest rates are already exceedingly low, and it’s unclear how “lowering” them a bit more will induce companies and individuals to change their behavior significantly. In the current situation, Fed Chairman Bernanke is cranking up the volume while the political system is sitting on its hands. Imagine a two-engine jet trying to fly with only one engine working. We need to really see both entities policies working in tandem to reap the maximum effect.
So where does this all leave us? We’re left with rates that are no better tomorrow than they are today. Now is the time to take advantage of the lowest rates in nearly 65 years. It is time to realize that if foreign powers decide to exercise their options and Wall Street/investors attitudes are still in the doldrums, and then later could very well be worse than now. As 2010 comes to an end there are also likely changes to loan programs for 2011 that could also jeopardize refinances next year that you could “get away with” this year.