Looking for a get-rich-quick scheme? Here is one guaranteed to pay off big time. Find someone who does not believe the Federal Reserve (Fed) will cut rates next month, give them whatever odds they want, and bet all your cash.
(Editor’s Note: the previous paragraph does not constitute sound investment advice and does not reflect the investment approach of Saving Advice, its staff, management, or anyone they know – even remotely.)
All kidding aside, the key takeaway from the Fed’s annual economic symposium at Jackson Hole, WY last week is that interest rate cuts are on their way. What is more, those cuts could be deep.
When the Fed talks about the federal funds rate, it means the interest charged to commercial banks when they borrow from or lend to each other. Consequently, moves in the federal funds rate directly impact the interest you pay on consumer loans and financing.
Further, rate cuts could trigger a downturn in consumer prices – although price declines usually trail rate cuts by several months
Evidence of Coming Rate Cuts
“The time has come for policy to adjust,” Fed Chair Jerome Powell said in his formal remarks at Jackson Hole. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Even before Jackson Hole, the July meeting of the Federal Open Markets Committee (FOMC), the wing of the Fed that sets rates, signaled growing support for a rate cut.
“All participants supported maintaining the target range for the federal funds rate at 5¼ to 5½ percent,” according to the July meeting minutes, “although several observed that the recent progress on inflation and increases in the unemployment rate had provided a plausible case for reducing the target range 25 basis points at this meeting or that they could have supported such a decision,”
Size of Rate Cuts
In addition to its September 18 meeting, the Fed will gather again on November 7 and December 18. Rate cuts could come at any or all of those sessions.
Traditionally the Fed cuts rates by a quarter point. However, a larger – half-point cut could be on the table. The August jobs report due September 6 will likely figure prominently in the size of any rate adjustment.
Although the current 4.3 percent unemployment rate is historically low, Powell has indicated that the Fed wants to keep it from rising.
“We do not seek or welcome further cooling in labor market conditions,” Powell said last week.
Interest rate traders and fixed-income markets are expecting significant cuts.
One barometer, the CME Group’s FedWatch Tool, is projecting that the federal funds rate will drop a whole percent by the end of the year. That would put the rate at 4.25 to 4.50 percent compared to the current 5.25 to 5.50 percent.
The FedWatch Tool measures the probability of fed funds rate changes based on futures contracts on the Chicago Mercantile Exchange.
How Rate Cut Affect You
A reduction in interest rates would lead to lower borrowing costs for you and businesses. That would result in sustained consumer spending, economic expansion, and new hiring by businesses.
As for investments, lower interest rates usually add fuel to financial markets. The thinking is that rate cuts lead to growth and higher profitability. As a result market sentiment and stock prices often rise as interest rates fall.
Recession Risk
The Fed’s primary job is to keep inflation down while sustaining full employment. That can be a tough balancing act. A tweak to far one way or the other can lead to financial hardship or disaster.
One big fear in the Fed’s battle with inflation has been that the central bank’s aggressive rate policy of the last year might push the economy into a recession. That is why Powell has consistently said the Fed is aiming for a “soft landing”.
A year ago, there was a great deal of wringing of hands and gnashing of teeth over the prospect of a soft landing averting recession. But, oh what a difference a year makes. Now most analysts see the economy discarding its R (for recession) rating for a PG (for prosperity generally) rating.
One of the main factors sustaining the economy’s strength has been steady consumer spending. However, there are signs that we consumers may not be able to keep up the pace without rate cuts.
Credit card debt has topped $1.1 trillion and delinquencies have risen for 11 consecutive quarters, according to Federal Reserve Economic Data. That said, as of August 19 only 3.25 percent of American credit card holders were delinquent.
“Modest, steady economic activity continues to be the path we appear to be on at this point, and there don’t seem to be signs of serious recession risk,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Nevertheless, a big question that may drive the markets and the timing of Fed rate cuts is whether consumers can continue spending at a sufficient pace to keep the economy growing.”
Certain Uncertainty
As indicated at the beginning of this article, federal rate cuts are coming. The only intrigue is – exactly when cuts will come, how many there will be, and by how much they will fall.
Powell has always maintained that Fed decisions are made based on data. Over the past couple of years, the main data influencing the central bank’s decisions has been inflation. However, with inflation on the descent, Powell and the Fed are shifting their focus to unemployment. As a result, what happens in the jobs market through the end of the year will likely be the prime influence on the frequency and size of rate cuts.
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