His remarks were echoed in similar remarks at the Commonwealth Club of California from Janet Yellen, president of the San Francisco Fed, who said it was "not outside the realm of possibility" that the Fed Funds rate would stay near zero for several years, Bloomberg News reported. While Yellen expressed optimism that things would turn up by year's end, she believed that the pace of recovery would be slow, and that risks remain.
Last week, the Federal Reserve said it was leaving the Fed Funds target rate unchanged, at a range between zero and 0.25 percent. In the statement accompanying the rate decision, the Fed said that "economic conditions are likely to warrant exceptionally low levels of the Federal Funds rate for an extended period." Observers viewed this comment as a signal to the bond market that the central bank would be inactive through the end of the year.
During her talk, Yellen went on to say that credit would remain tight for an extended period, and if the Fed were to raise rates, it risks stalling an economic recovery only shortly after activity bottomed out. Banks have just started to find solid footing, but with commercial real estate remaining a looming concern, much uncertainty remains.
Low short-term interest rates might not be good for your savings account, but it helps banks earn additional profits because they can borrow money more cheaply. In the first quarter, Bank of America (BAC) paid $2 billion less in interest on the deposits it holds, compared to the first quarter of 2008; these savings are directly related to the Fed's actions. Extend numbers like that out for several quarters and apply it to the whole banking system, and it's another way to help banking return to profitability (albeit a much subtler route than going to Congress).
El-Erian added that although he believes the Fed can hold down short-term interest rates, attempts to do the same to long-term interest rates will not be as successful. Long-term interest rates are a key driver of mortgage rates, and the Fed hopes that lowering mortgage rates can effectively lower housing costs to stimulate demand. To that end, the Fed announced it still intends to purchase up to $1.25 trillion in mortgage-backed securities.
James Cullen also edits and writes at CollegeAnalysts.com.