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Interest Rates: Where Do We Go From Here?
To say the past year and a half hasn’t been a wild ride in the interest rate environment would be a colossal understatement. We’ve seen the Federal Reserve increase interest rates 11 times in a historical attack on inflation. This has brought benchmark interest rates to the highest levels we’ve seen in 22 years. To understand where “experts” believe we are going, let us take a minute to review where we have been.
18 Months of History:
Post Covid the Fed made the decision to lower interest rates to help stimulate the economy. Quick Econ 101 lesson, when the Fed lowers interest rates it makes money cheaper. When money is cheap both consumers and corporations use it to their advantage. We refinance more expensive debt, and at the end of the day, there is more money in circulation to be spent. This was theoretically a good thing during an economic crisis like Covid.
However, one of the unintended (or intended) consequences of all this money in circulation is that it drives up the costs of goods (Econ 101 again, demand increases). This creates an inflationary environment, which is one of the key things the Fed is trying to impact (low inflation is one of the core mandates for the Fed). Since unemployment has been very well-behaved, the Fed has increased interest rates from .25% to – .50 % all the way to its current level of 5.25%-5.50% with the sole purpose of taming inflation, which has seemingly helped.
Where does that leave us today? As mentioned above, the Fed has flipped the script from a very low rate environment up to a much higher level. This has helped lower the Core CPI (Consumer Price Index) to a more manageable 4.39% rate and the PCE (Personal Consumption Expenditures) rate to 4.24%. What this tells us is that their aggressive interest rate hikes have ultimately had their desired effect. We went from rates over 7% to closer to 4% in 18 months.
It is important to remember that the Fed’s target inflation rate is between 2-3%. Even though we’re still above that level, the Fed held rates at current levels after the September 2023 meeting. The hope/expectation is that the effects of higher rates are on a lagging effect to run through the economy and that we’ll continue to see inflation levels come down to target as time moves forward.
We anticipate from here the Fed will keep a very watchful eye on where all their inflationary figures, along with unemployment, head from here. If we see inflation stay stagnant, especially with super-low unemployment, there is likely going to be more rate increases ahead. At the very least, rates would stay at these higher levels for longer.
If we see all these interest rate hikes run through the economy and markets as they should, there is a good chance the Fed is done raising rates for the foreseeable future. As a matter of fact, in this scenario, we would expect that midway through next year the Fed would likely start decreasing rates to a more terminal rate. The current market has priced in anywhere from no more increases to one more of .25%. Thus, economists are thinking we are basically done for now with maybe one more small increase left.
Assuming all this holds true, and inflation stays tempered, the question everyone will be looking to the Fed for is the timing of when they will start decreasing rates. We would expect no rash decisions on the Fed’s behalf. They are in no way looking to start lowering rates and then change course again. Rather, we would anticipate they are very cautious and data-centric over the next bunch of months. They’ll really want to see inflation continue its downward trajectory, and perhaps even a little uptick in unemployment.
For the time being, know that with these interest rates not going anywhere tomorrow, you will have a few key trends continue. You will continue to see borrowing costs on things like cars and homes remain higher than the extremely low rates we’ve been accustomed to over the past few decades. We will also continue to see our lower-risk asset classes like cash/money markets yield decent returns.
Most importantly, we will continue to keep a very close and watchful eye on economic data to stay ahead of the curve on not just market expectations, but also financial planning strategies to help bolster your finances. It is what we are here for and look forward to continually guiding you through the uncertain times ahead.
As always stay wealthy, healthy, and happy.