139 "There is some economic momentum that the market hasn't acknowledged," says LPL Financial Chief Market Strategist Jeff Kleintop, who believes the Fed could start raising rates in 2010. The Fed has pumped trillions of dollars into the financial system. A recovery will push that money out into the economy, where it can spike fears of inflation, he says. By contrast, those who believe rates will stay low are far more worried about the slow economy than rising inflation. The Fed is "going to find it difficult to raise [rates] much, if at all," argues William Rutherford, president of Rutherford Investment Management. "The economy is still not very strong in spite of the GDP numbers." First American Funds chief economist Keith Hembre says high unemployment is the main reason not to worry about inflation. "Labor costs are by far the biggest costs in the economy," Hembre says, and the large number of jobless Americans should continue to keep the cost of labor down.
The Fed's Very Fine Line Some worry the high federal budget deficit could push up interest rates. But Hembre argues the deficit could end up constraining economic growth in future years, as the government is forced to raise taxes or cut spending to fill it, a process that could further slow the economy. The Fed is walking a tightrope: Make clear that it takes the inflation threat seriously, but make sure it doesn't end economic growth before it really begins. "If they tighten [rates] too soon, before the recovery is stable enough, then they risk further weakening the economy," Li says. "If they do it too late, inflation becomes a problem." The direction of interest rates can have a big effect on investors. For example, the financial sector has benefited from lower rates, which has helped banks begin recovering from the huge losses of the last two years. "As rates rise, it raises the cost of borrowing for banks," Kleintop says. "Is our financial sector able to sustain a higher cost to their lending?" he asks, especially if those higher rates occur relatively soon—like in 2010. Lower interest rates hurt the value of bonds and might also damage the appeal of utility stocks and other equities prized for their dividend yields, Kleintop adds. Rutherford, who believes interest rates will stay relatively low, is investing money overseas. The reason is that low interest rates would tend to weaken the dollar, which
Villanova School of Business 2009 Media Report