Observed Levels of Interest Rates in the Market - Coursework Example

Observed Levels of Interest Rates in the Market Name: Institutional Affiliation: Observed Levels of Interest Rates in the Market Introduction According to DUFFY (2014). When making financial deliberations on where to invest, investors often base their decisions on stable prospects of growth in regard to economic and political stability. These prospect usually determine long-term investments such as insurance schemes and pension funds. Monetary policies that are accommodative of low levels of interest rates over the extended periods impact on economic investments both positively and negatively. The entire economy experiences a ripple when the Federal Reserve Board alters the interest rates within the markets. Interest rates in most economies express their presence by affecting inflation, bonds, and recession. It is well within the economic financial concept that existence of lower interest rates amplifies the level of spending within a given economy. Viewpoint from investors and economists on interest rates In an economic environment, resources are usually inclined towards those activities that present increased returns for risks borne by the lenders. The adjustments of rates on interests by the Federal Reserve are usually predetermined by anticipated inflation coupled with other risks. These offers a foresight of market signals on rates of the anticipated returns. Returns usually differ across the divide with economy bearing a rate of interest that is naturally extrapolated and are respectively dependent on such factors as investments and nation’s saving rates. In the event that economic activities are weakened, adjustment for anticipated inflation is triggered by monetary policy makers temporarily in order to lower the cost of borrowing. The economist perspective on lower rates on interest is based on the primary objective that decreased rates on interest acts in stimulating growth of the respective economy (DUFFY, 2014). Do the low levels of interest rates stimulate borrowing and thus hasten economic growth? FEDERAL RESERVE BANK OF ATLANTA, & FEDERAL RESERVE BANK OF ATLANTA (2016) propose that with low-interest rates individual businesses and companies are more inclined into making random purchases on properties such as cars and houses since they have disposable income. This model of spending is due to the knowledge that they have been fairly charged on funds that they have borrowed. Lower interest rates also grants both the businesses and the farmers beneficial aspects that propel them to purchase large equipment since there is minimal costs that are incurred in borrowing. It is therefore factual to state that there is a physiological ripple across the divide of consumers and businesses when the interest rates fall. Thus low-interest rates influence the productivity and output of a particular economy. Additionally, when investors want to invest into an economy, they do so by evaluating how the interest rates will directly impact on their investments. Federal funds rate act as major determinants of how the investors execute their investments. Interest rates also regulate the pricing of bonds. There exist an inverse relation between bond prices and interest rates in that low interest rate elicit the plummeting of bond prices in an economy. Governments and businesses raise funds through trading of bonds. High interest rates normally increases the cost of borrowing implying that lower-yield bonds demand ultimately drops and the pricing drops correspondingly. In the event that these interest rates are low, the cost of borrowing is downgraded and thus many companies issue fresh bonds for financial expansion purposes. This implies higher-yield bonds are put on demand and hence the bond prices move up (FEDERAL RESERVE BANK OF ATLANTA, & FEDERAL RESERVE BANK OF ATLANTA2016). With lower interest rates making it cheaper to borrow and consequently encouraging investment and spending, economic growth and high aggregate demand respectively rises causing inflationary pressures (Talks, 2016). In such an environment the Mortgage interests go down implying that their monthly payments are also decreased leaving most households with extra income at their disposal hence the amplified consumer spending. It is also worth to note that minimal interest rates lead to a rise in asset pricing. With interest rates becoming more manageable, it becomes inviting to purchase assets such as houses and hence the prices of such assets plummet. Such situations prompt wealth creation through spending and hence impacts on economic growth. Further, lower interest rates are associated with exchange rate depreciation. From an investment perspective, it becomes less inviting to invest or save money in an economy that encourages low rates on borrowed money since it amplifies the aggregate demand. An economy that discourages foreign currency causes its own currency to depreciate since there is a subsequent decrease in exchange rates (Talks, 2016). Reduced exchange rate prompts an economy’s imports to become expensive and respective exports more competitive in the global market. Yield curve as indicators for investors The adjustments of interest rates within the economy are promptly being varied without anticipated warnings. Hence, it is becoming more and more financially essential for investors to understand and explore the consequent implications of a varying yield curve. A yield curve refers to a graphical representation of the relationship that exists between interest rates pegged on treasury bonds that comprise of varied maturities and entail equal quality of credit. The yield curve slope acts as a means of forecasting on the economic growth (ANG, PIAZZESI, & WEI, 2004). Yield curves customarily take different shapes with each of the shapes having different implications on economic growth and thus subsequent impact on investments. Registered interest rates that are high, point towards the future possibility of inflation and economic growth and hence act as an indicator to investors. From an investors’ perspective future flow of funds is normally reduced at interest rates that are high as a result of inflation. Similarly, funds that have been invested as principal account for downgraded purchasing power on its future return and at a high rate of interest (ANG, PIAZZESI, & WEI, 2004). In an attempt to gain protection from inflation, investors opt to alter their portfolio allocations of fixed income by turning some of their funds into securities that have over the time been regarded as immune to inflation. Treasury Inflation Protected Securities refer to such securities that grants a principal at maturity point with the principal entailing adjustments for inflation. A normal yield curve that slopes upward designates a steady growth in economy which makes it attractive to the investors by giving them the desired boost in them the confidence to invest. In such a curve, the interest rates substantially differ in regard to different periods but essentially remain strong to sustain desirable prospects to the investors. In a steady and a healthy economy investors are guaranteed additional premium or yield that is an entity of longer maturity bonds (WRIGHT, 2013). This offers some logic to investors since the aspect additional premium covers for risks that are concomitant with the idea of having funds tied up for extended period. Yield curves that present a flat curve offer an indication of investors’ failure to procure compensations for extended risks that are related to investing on bonds that take longer periods to reach maturity. In such a curve, the economy is not guaranteed of solid growth. Similarly, the investment will consequently experience stagnation in its growth making it unattractive to prospective investors. In this type of economy economic indicators are not desirable and thus send mixed signals to investors (WRIGHT, 2013). In such situations, investors are often characterized by their prompt buying and instant selling of bonds and indication that they are cautious of the undesirable prospects of the economy. Hence, they are more comfortable in having their funds tied up in safe investments for extended duration since they demand little in return. An economy that is very bleak is usually characterized by an inverted yield curve. Such a curve indicate anticipated downturn of economic stalling. A stalled economy that is on the brink of experiencing a possible recession acts as a switch-off to prospective investors. In such cases, the investors shy away from investing their funds into projects and opt for safer ways to preserve their capital. In the process of preserving capital, the prices for longer maturity bonds goes up and the pricing of premiums goes down. Similarly, the investors fail to invest on short-term bonds resulting into reinvestments on the downturn. The absence of demand prompts the down pricing of the short-term treasury bonds and the rise in yields’ prices. An inverted yield curve is a clear indicator of the onset of a recession of the economy (ANG, PIAZZESI, & WEI, 2004). Low-interest rates and current economic malaise correlation Overall the global economy is facing enormous challenges with the US economy being one of the economies that are stuck at rock bottom in most recent years. This economic malaise emanates from fundamental challenges related to lack of demand that has been instituted by feeble spending and lack of investment rather than what widespread investors and the Federal Reserve claim to be global environmental challenges. As suggested by Talks (2016), the failure to establish a vibrant consumer base implies that there are no consumers to purchase the US’s services and goods and therefore the local companies shelve their interests in investing for the future. The fact that the US dollar remains consistently stable makes it the main agent that spur the high pricing of the country’s goods and services initiating a reduction in demand. In trying to improve this economic malaise and spur economic growth, the Federal Reserve has continuously tried to lower interest rates. This move by the Federal Reserve is based on good intentions and aims at stimulating investment through borrowing by reassuring investors on prospects of taking extended risks (Talks, 2016). Although the Federal Reserve perspective is founded on good intentions, by lowering the interest rates aids in creating a market bubble within the country’s economy. In circumstances where investors fail to recoup interest on investments that they consider as being safe such as bank’s certificate of deposit and treasury bonds. To generate income in such economies the investors take more options in riskier assets. Fundamentals like fragile corporate earnings, situational wage inflation, deprived GDP are habitually ignored by market participants with the Federal Reserve consistently securing the markets with a zero rate policy on interests. The reason for these low-interest rates is as a result of Europe's Central Bank who aggressively work to secure the European economy by copying the Federal Reserve. The Fed insist on quantitative easing through the purchase of bonds that target on injecting liquidity into the market. By doing so, the Dollar consistently remain competitive contrastingly making it challenging for the Fed to impose higher interest rates on the economy. This challenge is prompted by the fear that the rise in interest rates would prompt an amplified drag in United States global trading (Talks, 2016). Regardless of these outlined facts on low-interest rates creating a market bubble in the US economy by stimulating short-circuit in the financial market and stifling capitalism, it is clear that the rates are not the primary contributor to the current economic malaise. The root cause of this malaise is squarely blamed on consistent lack of investment and weaker spending in the consumer base. Expansionary monetary policy by the Federal Reserve is another contributor to the economic malaise (Talks, 2016). This policy acts in suppressing long-term rate and by doing so, the yield curve is flattened. These actions instigate in squeezing the margins of bank profits leading to decreased economic growth and investments into businesses. Federal Reserve intervention To correct the economic anomaly, economists have suggested that the Federal Reserve ought to intervene and sway the treasury market by widening the margin that exists between the short-term and long-term interest rates in an attempt to steepen the yield curve. Other economists argue that this is rather not the right approach in correcting the anomaly since it is forthright that a sustainable market and strong economic growth is not based on artificial stimulus. They further argue that, to steepen the curve the policies instituted by the Fed such QE/ quantitative easing that divert capital from investments considered as being long-term should be put on hold. Commissioning of such economic steps will eventually allow for growth on investments, revitalized productivity, and giving life to the now stagnated wages. As suggested by BOMFIM (2013). rather that the prompt intervention by the Federal Reserve, policies that are designed to grant economic incentives that include lowering of taxes for corporations and individual businesses should be adopted to help spur economic growth. Bibliography ANG, A., PIAZZESI, M., & WEI, M. (2004). What does the yield curve tell us about GDP growth? Cambridge, Mass, National Bureau of Economic Research. http://papers.nber.org/papers/w10672 BOMFIM, A. N. (2013). Finance and economics discussion series: monetary policy and the yield curve. [Place of publication not identified], Bibliogov DUFFY, J. (2014). Experiments in macroeconomics. Bingley, U.K., Emerald. http://public.eblib.com/choice/publicfullrecord.aspx?p=1865244 FEDERAL RESERVE BANK OF ATLANTA, & FEDERAL RESERVE BANK OF ATLANTA. (2016). What’s Moving the Market’s Views on the Path of Short-Term Rates? Macroblog: Federal Reserve Bank of Atlanta. 2016-07 Talks, M. (2016). Do ultra-low interest rates really damage growth? | All About Money. Allaboutmoneytalk.url.ph. Retrieved 18 October 2016, from http://www.allaboutmoneytalk.url.ph/money/do-ultra-low-interest-rates-really-damage growth/ WRIGHT, J. H. (2013). Finance and economics discussion series: the yield curve and predicting recessions. [Place of publication not identified], Bibliogov Read More