January 16, 2013

Headwinds Will Keep Interest Rates Low

Posted in Economy, Taxpayer Relief Act, Uncategorized tagged , , , , at 5:46 PM by Robert Barone

On Jan. 2 when President Barack Obama signed the American Taxpayer Relief Act of 2012, there was no pomp and circumstance that has been characteristic of this administration.

That seemed strange given the fact that the president got much of what he wanted in the so-called “fiscal cliff” bill. I expected to see several “middle-class” families at the signing ceremony, applauding the president for saving them from significant tax increases.

But they were strangely absent and with good reason. Like much of what comes out of Washington, the title of the legislation is 180 degrees opposed to what the legislation actually accomplishes, for this was not a taxpayer relief act! After two years of campaigning to tax only the “rich” and protect the middle class, there was no pomp and circumstance because the middle class got the shaft.

$125 billion






1040 Taxes

2012 (4.2%) Payroll Taxes

2012 Total Taxes

2012 Eff

Tax Rate





























1040 Taxes

2013 (6.2%) Payroll Taxes

2013 Total Taxes

2013 Eff

Tax Rate

Tax Increase

Tax Pct Change

























The table packaged with this column shows an estimate of the 2012 and 2013 taxes on Americans of modest means (middle class). These are wage earners married, filing jointly and making $48,000, $60,000 and $72,000 with adjusted gross income on their 1040 forms of $40,000, $50,000 and $60,000, respectively.

As you can see, taxes for 2013 have increased by 2 percentage points for the same income and AGI levels for the middle class (see the 2012 and 2013 Effective Tax Rate columns).

The amount of tax increase on a family making $48,000 with an AGI of $40,000 is nearly $1,000. For these middle-class folks, taxes have risen by 13 percent for a total reduction in disposable income of $125 billion, according to Michael Feroli, a JPMorganChase economist. Ouch! Such tax increases are sure to have an impact on consumption and economic growth.

Spending negotiations

While Congress and Obama reached a last-minute deal on taxes, the spending and debt ceiling issues remain unresolved. We can assume with a relatively high level of confidence that in the upcoming round of caustic negotiations, there will be some cuts to spending, even if they are out on the horizon.

But, for sure, immediate spending won’t be going up, and there likely will be cuts to programs for state and local governments. Such spending control, or even a semblance of it, will put downward pressure on economic growth. Generally, when growth is slow (and when the Fed is pushing easy money), interest rates remain low or are falling.

Housing headwind

Investors today are being told to stay away from fixed-income investments because interest rates are sure to rise. Given that rates are at historic lows, that statement undoubtedly is true. The question is, “When will they rise?”

Recognize that, besides the issues I have outlined, rising rates will create yet another headwind in the housing finance market.

Mark Hanson is a mortgage market specialist in the Bay Area. He recently said that “there is absolutely no doubt that the unprecedented 5.25 percent midyear 2011 to 3.5 percent midyear 2012 Fed-induced plunge in mortgage rates had a positive impact on refi volume, consumer cash-flow (emphasis added), home sales …”

Anything, he said, that reduces refi volume will have a large impact on consumer cash-flow. “If rates remain flat at 3.5 percent, refi burnout will take fundings down 33 percent … If 30-year rates hit 4 percent, at least half of all refis … will evaporate literally overnight.” That will significantly impact disposable income growth.

The Fed

During the first week of the year, the minutes of the Dec. 12 Federal Open Market Committee (i.e., Fed minutes) were released showing a dispersion of opinion among the FOMC members:

“Several others thought that it would probably be appropriate to slow or stop purchases (of securities for the Fed’s portfolio) well before the end of 2013 citing concerns about financial stability or the size of the balance sheet.”

The investment community became concerned and as a result, yields on 10-year Treasury securities rose from 1.7 percent to over 1.9 percent, and this has led to the concerns over fixed-income investments expressed above.

David Rosenberg, a noted Wall Street economist, examined all the past FOMC minutes since the economic crisis and found similar language in the FOMC minutes of April 15; April 27, 2011; March 15, 2011; Nov. 3, 2010; and April 28, 2010. Each time the market reacted initially by pushing rates up proved to be a buying opportunity for fixed-income investors.


In the face of a significant rise in taxes for America’s wage earners, downward pressure on government spending and the hit to housing finance that rising rates would bring, it looks doubtful that interest rates can rise significantly anytime soon.

The Dec. 12 minutes didn’t contain any new information; we have seen it all before. So, fixed income investors should take heart; rates don’t look like they can rise significantly from here in the near term..

Taxes on American income levels

This table shows an estimate of the 2012 and 2013 taxes on Americans who are married, filing jointly and making $48,000, $60,000 and $72,000 with adjusted gross income on their 1040 forms of $40,000, $50,000 and $60,000, respectively.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

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