Since March of 2022 the Fed has raised interest rates nearly a dozen times with the last quarter percent hike happening more than a year ago. Despite Chairman Powell’s insistence that rates must remain high to curb inflation, interest rates have been falling in recent weeks. In fact, according to Freddie Mac mortgage rates have fallen to the lowest level in more than a year. As of this past Thursday, the average rate stood at 6.47% more than a full percentage lower that its peak last year.
This change in rates is not only impacting how much you have to pay in interest, but also what your money is earning. The yield paid on 10-year Treasury bonds have fallen sharply in the past few weeks. As are the rate’s fixed annuities are offering to their customers. In the coming days and weeks, I would also expect the amount you receive in your high interest savings accounts to also begin to shrink.
You may be wondering why this is occurring when currently Federal Reserve rates remain at their highest levels since 2001. The simple answer is while private interest rates are influenced by the Federal Reserve, they are not set by them. Other factors such as employment numbers, the consumer price index and the general perceived strength of the economy also play a role.
In fact, there is a common misconception that the Fed dictates the rates banks will charge and pay on borrowed money. At times, the opposite is true. Sometimes the private sector actually influences the fed in determining its monetary policy. As lenders take action to raise or lower the rates they charge borrowers, the Fed will often react in-kind.
An economics professor I had once compared this relationship between the Federal Reserve and private lenders as a couple dancing. Sometimes the Fed leads and the banks follow, sometimes the banks lead, and the Fed follows, and on some occasions, they are each dancing separately to their own tune.
I would argue much of what is causing private sector rates to drop is a belief that based on a weakening economy, the Fed intends to announce rate cuts soon. But what happens if they don’t? After significant market drops recently the S&P rallied to be up last week, showing there may still be gas in the tank on this bull run.
In his most recent statement, Chairman Powell did acknowledge a rate cut could come as soon as September but was less than definitive in saying it would happen. The Fed chair also expressed a shift from solely focusing on inflation to both inflation and employment concerns. A sign to many that cooling economic conditions could lead to multiple rates cuts this fall.
As someone who has personally benefited from these increased rates, I am not at all bothered if the Fed chooses to not try and force rate cuts now. After all, the artificially low rates that the Fed set for more than a decade played a big role in how we got into this mess to begin with.
Inflation is too dangerous to let creep back up. If it means a slight rise in unemployment and a market contraction, I personally am ok with it. Erring on the side of caution is, in my mind, always the best strategy. To me, the long-term benefits of some short-term pain will be well worth it.
(Past performance is no guarantee of future results. The advice is general in nature and not intended for specific situations)