Fed Lays Groundwork for Higher Rates with Unexpected Hike

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Maybe it was only symbolic move.   On Thursday, the Federal Reserve hiked its lending rate for emergency bank loans known as the “Fed Discount Rate” from .5% to .75% in an off-cycle meeting.   While this rate affects little in the day-to-day bank-to-consumer lending, the Fed could be prepping us all for changes in its easy money policy.  Many analysts seemed concerned that the move seemed preemptive, especially since it took place before the March 16^th Federal Open Market Committee meeting.

This easy money policy of course is critical to the economic recovery process.  However with dissent occurring amongst the policies needed to spur the US economy, the hike could signal the concern for the mounting deficits from government spending.   The economy grew by an estimated 5.7% in the 4^th quarter 2009, but with unemployment hovering around 10% nationally, the thought of significant economic expansion, warranting inflationary pressures seems out of place.   Not everyone agrees.   James Bullard of the St. Louis Federal Reserve has been outspoken lately on his concern for inflation citing the financial markets are worried about inflation.

The big question is when the Fed will act on the Fed Funds Rate.  The Fed Funds Rate is the primary rate which banks borrow money which is translated to the Prime Lending Rate.  The Prime Rate is the barometer of consumer lending.

Let’s take a look at the Fed Funds Rate over the last 10 years (Courtesy Federal Reserve Bank of St. Louis):

We often forget the wild swings in interest rates.  Notice in 2000 the Fed Funds Rate was at 6.5% which translated to a 9.5% Prime Rate in May of 2000.

With economists expecting Ben Bernanke to shed light on the sudden move lately in the Discount Rate, he’ll likely be cautiously optimistic on the economy.  I say cautiously because the markets are too jittery for them to signal worry over inflation and growth when unemployment is high.  My friend and Economist, Juan Sacoto of Informa Economics, reminded me yesterday of the strong placebo effects of confidence.  “Nearly 70% of the economy is consumption,” he stated.  “Unemployment getting below 6% is when the American public feels highly confident and periods of significant expansion occur.  We’re several years out from this number,” he added. This leaves the Fed playing a delicate balancing act of sounding confident while laying the precedent for tightening under a weak economy.

Calculated Risk predicts the Fed Funds Rate won’t budge until at least 2011. Other economists agree.  It could be the Fed is trying to merely set the stage today ensuring when the tightening comes, markets maintain stability. You be the judge.

I hear many would-be-investors trying to time the real estate market based on real estate prices, while entirely missing the boat that the era of cheap money has limited mileage left.  Locking in your real estate investments on low rates is one of the biggest aspects of controlling your cash flow with your buy-and-hold strategy.   While overall costs of borrowing are likely to remain low over the course of the next 12-24 months, the Fed move on Thursday will be remembered as the first signal towards the move to more expensive money.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.