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In an Election Year by Michael Licamele |
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Will political pressure push interest rates lower during the 1996 election year? Should consumers wait until just before elections to lock into a mortgage rate? While the election theory of interest rates may have guided interest rates in the past, recent history shows otherwise. As a result, consumers should not rely on politics to help them lock into a lower mortgage rate this fall. On September 24, 1996, the Federal Reserve Board voted to leave interest rates unchanged. While many analysts might see the Board's inaction as politically motivated, a review of current economic conditions show that a strong economic case can be made for a neutral interest rate policy at the present time. Inflation in 1996 is under control and the economy is growing at a reasonable rate, eliminating the two major reasons for increasing rates. Prior to the 1990's, most interest rate forecasters were in agreement that the Federal Reserve would not move to increase interest rates during the months before a November presidential election. Looking back over the past several decades, it is evident that the Federal Reserve has adjusted its policy in response to economic, not political conditions. While the Federal Reserve has not made major changes in rates during these election years, the interest rate markets have been rocked back and forth by several market forces. It is these forces of market expectations, inflation and international interest rates, much more than current Federal Reserve policy, that will have the greatest impact on the direction of interest rates this fall. Long-term interest rates are much more dependent on inflation levels than on short-term interest rate adjustments by the Federal Reserve. Inflation erodes the value of long-term fixed rate investments (such as mortgages). Interest rates required by investors to compensate for inflation losses rise, which increases mortgage rates. A review of interest rate movements over the past three presidential election years shows no relationship to lower interest rates. In 1984, interest rates increased steadily from January straight through the reelection of Ronald Reagan. Rates did not begin to decrease until 1985. Federal Reserve policy at this time was tough, but inflation pressures pushed long-term fixed rate mortgages above 12%. In 1988, George Bush was elected President while both Federal Reserve policy and market interest rates held relatively steady. Fixed rates mortgages had dropped to the 9% to 11% range. At that point, a weakening economy had slowed the increase in the inflation rate, allowing interest rates to decrease. Finally, in 1992, the Federal Reserve actually decreased short-term interest rates to help jump-start a faltering US economy. Mortgage interest rates were actually decreasing while George Bush lost handily to Bill Clinton. Analysis of these three election years clearly proves three facts: First, the Federal Reserve has maintained tough, neutral and accommodating monetary policy over the last three elections. Second, interest rates have been increasing, steady and decreasing during these election years. Finally, whether interest rates are increasing or decreasing appears to have no impact on the outcome of a presidential election. While interest rate levels do have a major impact on the lives of consumers, issues such as unemployment levels and non-economic issues can be much more important. According to election year theories, lower interest rates should have catapulted George Bush to a second term. Similarly, Ronald Reagan should have been soundly beaten for allowing interest rates to remain so high (although nominal rates had been much higher in 1980, real interest rates actually rose). With less proof that lower interest rates help reelect an incumbent, there is less political pressure on the Federal Reserve to tailor policy to dovetail with election years. By excluding the election year theory from interest rate predictions, it becomes obvious that inflation levels combined with national and international market forces have had much more impact during election years than Federal Reserve policy. When inflation has risen, so have long-term interest rates. When economic signals have pointed toward more inflation before it even occurs, long-term rates have risen. And when interest rates in other countries have decreased significantly, so have US interest rates. These relationships have held much stronger than any election year links. Finally, one need only look back to the 1992 fall election cycle to see the danger of relying on election year interest rate theories to lock in on a mortgage rate. In the summer and early fall of 1992, interest rates decreased until the beginning of October. In early October, however, interest rates increased nearly one full percentage point within a two week period. Those home buyers and refinancing homeowners waiting for still lower interest rates were rudely awakened when their fixed rate loans increased from below 7% to over 8%. No one theory has consistently predicted interest rates or economic conditions over the past fifty years. If a consumer has held off buying or refinancing because of this year's relatively high interest rates, he or she should consider taking a 3-, 5-, or 7-year adjustable rate mortgage now and refinancing later whenever rates decrease. For consumers who want or need to lock into a fixed mortgage rate this fall, their best bet is to find the lowest rate they can in today's market and lock into that rate right away. A borrower can almost always refinance into a lower mortgage if interest rates drop in the future. Michael Licamele is Editor
of The Mortgage Almanac. |