Bold action by Fed increases odds of soft landing
The Federal Reserve began its historic pivot on Sept. 18 moving to unwind interest rates and stave off recession.
The 50-basis point move on Sept. 18 met Wall Street expectations for bold action and was greeted with relief and rising stock prices. In remarks after the meeting Chair Jay Powell talked about the Fed’s confidence that inflation was coming down and opening room for additional cuts
The beginning of a rate-cutting cycle after a period of high interest rates could be one for the history books.
Blackrock’s Rick Reider said the move will usher in a “golden age of fixed income,” with rates moving down and rewarding bondholders.
Indeed, a sustained effort to bring down the Fed’s short-term target to a “neutral rate of” 3%, in line with inflation at 2.5%, would cut yields to something like 40% on the shortest maturities.
If the Fed continues its journey toward normalization, there will be broad economic and political impacts:
• Banks and borrowers will both get some breathing room. The squeeze on bank profits will ease as spreads between what banks earn on loans and what they pay out in short-term deposits widen. Consumers will see rates on credit cards, auto and consumer loans come down and if unemployment remains low, they should be able to pay off debts without dipping into savings.
• The commercial real estate lending crisis may slowly unwind. Lower rates will reduce the cost of all sorts of real estate loans making it easier to refinance troubled properties and also easier to finance new construction, especially those pricey conversions of offices to residential or other uses.
• There could be a revival in home lending and new home construction. Builders need streamlined permitting and a YIMBY attitude from more large cities but reducing the cost of acquiring lots and financing new homes, existing homes and affordable housing projects will help a lot. Thirty-year mortgage rates could fall well below 6% and move down further as the Fed’s easing cycle proceeds.
• Savers will have to extend their CDs out longer and move their money market funds into longer-term funds in order to get higher yields. But a normal yield curve where longer maturities command higher rates makes for a more stable fixed-income market and economy.
• Optimism about the economy could have an impact on attitudes about the future of the country headed into the election. And while the Fed says politics plays no role in policy-making, early ballots are already arriving in the mail in some states as it takes an epoch-making step.
There are plenty of potential actions that could derail the Fed’s best-case scenario.
Inflation could reappear causing the Fed to pause its easing cycle. The employment situation could deteriorate rapidly putting the Fed once again behind the curve.
Inflation could creep back into the economy thanks to an oil shock, supply chain disruptions, or a too-forceful rebound, forcing the Fed to reverse course.
The government’s spiraling deficits could trigger a return of the bond market vigilantes who will demand higher rates for Treasury bonds no matter how hard the Fed leans toward easing.
On a personal note, I was a reporter in Springfield, Massachusetts in 1982 when the Fed regained confidence in the economy after two bouts of inflation and began a rate-cutting cycle that was, with a few speedbumps in the 1990s, sustained across decades.
At that time the Dow Jones Industrials were below 1,000 and rates were in the double digits — I remember earning 12% on two-year Treasury securities that I bought.
When I talked to him on the phone last week BMO economist Scott Anderson said he expects rate cuts at the next six consecutive Fed meetings, with relatively little risk.
To offset lower interest rates on savings, he said there should be a wealth effect from a rising stock market and home prices.
“There’s nothing really in the economic data that scares me too much,” he said.
With today’s action, the powers that be at the Fed seem to agree.
