The Fed Delivers on Its Promise of Lower Interest Rates
A guest column by our friend, Hal Burris, on the recent lowering of interest rates to 5%: Relief for borrowers and a cautious domestic optimism mixed with tensions beyond our borders.
By Harral Burris
On Wednesday, the Federal Reserve cut interest rates by 0.5% from 5.5% to 5%, and it signaled that more relief is on the way if needed. A rate cut was all but certain, with the only question being whether to cut 0.25% or an unusually large 0.5%. Even lower rates will be needed if the labor market continues to cool and indications of a possible recession become apparent. Two and a half years after instituting the most aggressive rate hike campaign in a generation, the Fed thinks it has brought inflation back under control without inducing the usual recession. The Fed can now begin a gradual reduction in US interest rates.
The key word here is gradual. Investors and potential home buyers shouldn't expect a rapid fall in rates. They will likely see them quite a bit higher than the historically low levels that have been around in some fashion since the financial disruptions of 2008, especially since the sharp business contraction brought on by the COVID lockdowns.
In this recent update, the Federal Reserve Board of Governors projects a final federal funds rate of 2.8% to 2.9%. That is the rate policymakers think will prevail in a balanced economy with a strong labor market and low and stable inflation. It is significantly lower than current rates, but well over the near-zero rates that prevailed for many years.
Rates are decreasing, but mortgage rates are not returning to less than 3%. Since 1950, the average 30-year fixed-rate mortgage has been around 5%. Perhaps rates can fall back to these levels from the current level of just under 7%. Do not expect free money to purchase over-priced houses, as was the case before COVID.
A round of rate hikes to ward off inflation usually leads to a recession, but maybe not this time. Stock valuations are at record highs, jobless claims remain below 250,000, economic growth is north of 3%, the unemployment rate is at a historically low 4.2%, and inflation is now running just over 2%. Although Fed Chairman Jerome Powell has caught a lot of grief from both political parties, he might have pulled off the impossible: inflation has been tamed without a recession.
Today's rate cut won't be an immediate game changer for households and small businesses. Borrowing costs were well below historical levels for almost two decades, so folks might need time to adjust to the new normal. Interest costs will remain higher than borrowers have become used to, but at least rates are moving in the right direction.
Be aware that it took almost 20 years for mortgage rates to fall from 7% in 2001 to levels under 3% in 2020 – at the height of the pandemic. Mortgage rates have never been that low before, and they’re not likely to go back to those levels anytime soon. Powell stated, “If the economy evolves as expected, the median estimates project that the appropriate federal funds rate will be 4.4% at the end of this year and 3.4% at the end of 2025.”
All eyes should be on the labor market for a hint at the future direction of rates. If the unemployment rate rises above 5%, the Fed could drive rates down at a faster clip.
There has been speculation about political bias at the Fed, especially on the eve of a tight election. Those accusations are off-base. Powell was unequivocal on the subject at Wednesday’s press conference. “This is my fourth presidential election at the Fed. Anything we do before, during, or after the election will be based on the data, the outlook, and the balance of risks.” That is a credible statement and markets widely agree.
There are serious questions, however, about the geopolitics of this rate cut. JPMorgan CEO Jamie Dimon thinks people are overly focused on the domestic economy, warning that international tensions pose the biggest threats to global markets for the foreseeable future. Dimon stated, “The most important thing that dwarfs all other things is the war in Ukraine, what’s going on in Israel, in the Middle East, America’s relations with China, and the attack on the rule of law that was set up after World War II. That’s really far more important today than it’s been probably since 1945.”
Dimon’s concerns are widely shared in Washington, on Wall Street, and abroad. The Fed has managed the American economy as well as anyone could hope, and the United States is in a strong place, but the future looks less bright outside our borders. Cautious optimism is probably the best way to plan ahead.
Hal is a retired investment professional with 40 years of experience in money management. The interface between geopolitics and global investments has always been his area of specialization. History has always been one of his interests and passions, in fact, that’s how Hal and Jeremi became friends in Madison, Wisconsin.