Interest rates have been elevated for over two years now. This is the result of the Federal Reserve fighting the post pandemic inflationary fire. Higher rates are the primary way to lower inflation, and this is a time tested remedy, rewarding savers, while punishing borrowers and some investors.
Let’s look at where we are now, where we’re headed, and the anticipated impact of the coming changes.
Where We Are
Higher rates have rewarded cash savers for the first time in a generation. With money market rates exceeding 5%, it’s been a nice return for zero risk. CD yields have been juicy too. It’s a boon for those who can’t stomach investment risk, and very nice for those of us who hold some cash in a diversified portfolio. For others it has been a painful struggle.
Bonds are important to all but the most aggressive investors and bond prices tanked as rates were pushed up. A bond’s price moves inversely to yield (interest rate). Yields going up means prices going down, and that’s painful when bonds are supposed to offer safety.
Home prices spiked as the pandemic peaked, and the value of everything went up all at once due to the flood of cash that led to the inflation spike. This was followed by a painful increase in mortgage rates. These are the highest mortgage rates in a generation, keeping many people out of the home market. People with super low mortgages had no incentive to move, and trade up or downsize, which translated to a lack of sellers and homes families and aspiring families could afford.
Lending markets of all types have struggled making it harder for the economy to grow, while higher rates have tamed an economy that was on fire with inflation. The list goes on regarding the pain of higher rates. Auto loans have been a burden for many families, and small businesses have struggled with financing because they tend to borrow for shorter terms at rates that are higher even when rates are “normal”.
Where We’re Going
Inflation by all measures is trending back toward pre-pandemic norms, which is around 2.5%. The job market is finally showing some signs of slowing. This combination frees the Fed to begin cutting rates, and they’ve made it pretty clear this will begin at their September 18th meeting.
The market anticipates three to four rate cuts, totaling 0.75% to 1%, by the end of 2024, with a potential 2% drop over the next year. However, economic conditions can change rapidly.
The prices of longer term bonds have already begun to rise in anticipation, with people who sell bonds for a living waxing philosophically about the once in a generation opportunity in bonds. In my humble view, this is just getting back the once in a generation loss we experienced as rates spiked. Either way, bond prices rebounding is great news, getting us back to a new normal.
Mortgage rates will drop significantly as well. They are already down more than 1% from highs in many markets. That trend will continue, and hopefully, the residential real estate market will rapidly thaw as we head into spring.
Car loans will drop, allowing families to make better transportation decisions, and keeping auto workers employed and spending those paychecks further bolstering the economy.
Risk averse savers will have to say goodbye to juicy money market and CD rates.
Wrapping It Up
In many ways, this marks the end of pandemic era financial turbulence. The ride down in rates will be refreshing for all but the ultra-conservative saver.
The trick for the Federal Reserve will be getting rates down fast enough to prevent a recession, which markets call a soft landing. While bond prices may move quickly in economics there is a strong belief that it takes six months or more for any rate change to fully play out in the economy. A September rate cut of ¼% will not be felt in American homes and businesses until March. If a recession should happen next year, the consensus is that it will be short and shallow, with the headlines being worse than the reality for most.
If you have been enjoying the high money market and CD rates, we’re here to help you build a portfolio that meets a conservative risk tolerance for the long run.
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