As anticipated, the Fed announced it plans to keep short-term interest rates low for an extended period because there is low inflation and high unemployment. The Fed also suggested it could begin purchasing more bonds, keeping interest rates low to stimulate growth. This quantitative easing increases the money supply by flooding financial institutions with capital to promote increased lending and liquidity. We subsequently saw the yield curve flatten a little more, as 30-year treasuries dropped 21 basis points to 3.74%. The five-year treasury also plunged 17 basis points to 1.26%—one hundredth of a percent higher than its all-time low.
In “better late than never” news, the National Bureau of Economic Research (NBER) announced the recession is officially over, and that it ended 15 months ago. The recession began in December 2007 and lasted 18 months. However, it took until December 2008 for NBER to recognize it because there is no official definition of a recession. Academically, an economy is considered in a recession after it experiences two consecutive quarters of negative growth, as measured by a country’s gross domestic product (GDP). The NBER defines a recession as a contraction in economic activity that shows a decline in real earnings, real GDP, employment, industrial production and retail sales that last for more than a few months. With such a broad and vague definition, NBER waits for the readings to be released and then revised again and again before they will make a call. The final numbers of the recession show we lost 7.3 million jobs, economic output fell 4.1% and Americans’ net worth fell 21%.
Now with several months of increase in industrial productivity, increases in manufacturing activity, and an increase in GDP, we are only missing the employment portion of the economy. Since the recession ended, we have lost 330,000 jobs, which is why so many people feel we are still in a recession. With a 9.6% unemployment rate, this sentiment is not surprising.
Through the end of Thursday, Sept. 23, the Standard & Poor’s 500 Index is down 0.7% but the Dow Jones Industrial Average is up 0.5% for the week. The Financial sector was hurt the most. It was down 2.6%, likely a result of the flattening of the yield curve. Banks will have to begin lending with the long-term rates falling and the short maturity yields rising. Most people do not realize that banks’ net interest margin is impacted by the flattening of the yield curve. Banks tend to borrow on the short end and lend long term so that their interest expenses remain less than the amount of returns generated by investments. With the yield curve flattening, banks will be making less. The way for banks to counteract lower long-term Treasury rates will be to lend more, as their profit from lending should now be greater.
Additionally, the Small Business Jobs Act of 2010, which passed by both the Senate and the House and is waiting on the president’s signature, should provide $30 billion for community banks to lend to small businesses. Thankfully, banks that are lending have been adamant about credit quality, so we should not be in danger of banks lending to businesses that are not creditworthy. Ideally, the government entices the banks to lend, and that lending allows businesses to grow and begin to hire. Near 70% of GDP is consumer spending, and we likely will not see a significant increase in spending without more employment.
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