The Federal Reserve Board recently announced that it was committed to keeping key interest rates near zero until late 2014. This policy is intended to create jobs and stimulate the economy by making borrowing less expensive. When money is cheaper to borrow, it flows more freely.
But the announcement, which surprised some observers, can have many implications, not all of which are immediately clear.
Let’s start with the positives. Keeping money cheap for banks and other institutions does mean it will be easier for them to lend to businessesat low rates. And banks will have more certainty about short-term funding costs, which in theory at least should allow them to be more generous with lending.
U.S. financial institutions should benefit from fixed low-cost borrowing and incremental earnings gained from lending long term. In addition, stronger corporate profits and excess cash could lead to an increase in dividend payments over near term.
Therefore, investors should find the equity market attractive as not only a source for potential capital gains but also a rich source of dividends.
And mortgage rates may remain historically low, which makes buying a home more attractive. Also, refinancing will make sense for more people allowing them to pay less per month.
However, the Fed’s super-low-interest policy also has some downsides.
For one, the dollar will remain weak. Investors will look overseas to make money in short-term investments and may be tempted to dump some of their U.S. dollar holdings. Already the Australian dollar has benefited, and other nations’ currencies may follow suit.
Investors who keep their money here will now face reduced yields on certificates of deposit, savings accounts and Treasury bonds.
Some economists warn that increased borrowing spurred by low interest rates can lead to inflation. Others say bursting bubbles, such as the one that hit the housing market starting in 2007, also may result. And investments that tend to do well in inflationary times, such as platinum, gold and silver, already have gotten a jolt.
So is high inflation a certainty? Should we all be buying gold?
Not at all. What the Fed’s announcement really means is that the central bank won’t make dramatic changes any time soon. For most individual investors, that means the best policy might be to stay the course – avoid big short-term shifts and continue to search for value stocks that pay dividends.
Tags: borrowing, Federal Reserve, interest rates, stocks, value investing