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A Government Shutdown & Higher Rates
What if interest rates don’t go down anytime soon? I spent the last podcast episode making the case that we cannot consistently predict the future. I said that a better strategy, particularly when it comes to our finances, is to prepare for a few different scenarios. So let’s explore a scenario that not many people are talking about today. What if interest rates don’t go back down soon and settle into this range for the foreseeable future? If you were born around 1988 or later, you might think mortgages in the 3% range are normal. But historically speaking, they are abnormal. If you talk with anyone who was buying a home in the 80’s, some of them will remember having a mortgage in the double-digits. Did you know that the Prime Rate actually got up to 21% in 1980? Now those were abnormal times as well – on the other end of the spectrum. But 3% mortgage rates are not normal and we may not see them again in our lifetime. 8% rates have actually been quite normal historically, and after the Fed met last week, that is just about where we are on home mortgages.
Every time the Fed meets, they update what is called the dot plot. The dot plot is a set of predictions for each of the members of the Fed about where interest rates will be for the next few years. Whereas back at the June meeting the dots indicated that many members of the Fed expected they would be cutting rates sometime next year, in this meeting’s dot plot expectations of cutting rates were still there, but those cuts were expected to be less. Maybe 2 rate decreases expected by the Fed in the next year. This sent a signal to the bond market that the Fed might be willing to hold rates at current levels or maybe even a little higher for longer, because right now the economy is still chugging along, even though it has slowed in certain sectors. The Fed is wondering if we need to give it more time for these higher rates to take effect or do we need to go even higher to see the impact of higher rates in slowing down the economy. So rates are higher across the board, particularly on the 10-year and 30-year government bonds. Think of increasing interest rates as a brake on the economy. It is not a targeted scalpel; it is more of a sword. It is not exactly precise, and the Fed does not know how those rates will affect the economy.
Let’s throw a scenario out there – what if 7% mortgage rates and the Prime Rate of 8.5% last for the next five years? How might that affect you? Well, for one thing, you are less likely to move if you currently have a mortgage in the 2-3% range. If you change jobs you might move, but unless your home is paid off, you would be less likely to move. But even if your home is paid off, you know how high home values have gotten. Unless you are downsizing, it probably doesn’t make sense to pay more per square foot than the house you are currently in. This might lead more people to do renovations instead of moving. If you want a more up to date house, you might consider renovating the bathroom or updating the kitchen. Or if you want more room, you might add a playroom to the back of the house. These options are a bit more typical and might be something you want to consider if we end up finding rates sticking around in this range for 5 years or so.
If you own a small business, you are not as likely to borrow money because the cost of doing so has gone up. You might even do the opposite and begin paying down your debt. If that happens, that means demand for credit, or the degree to which people want to borrow money, would go down. If demand for credit goes down, banks don’t have the opportunity to put depositors’ money to work as easily, they don’t have as many places to lend it out. So you might see rates that banks are paying go down a bit. CDs in that scenario could settle into the 3-4% range over that 5-year period of time. That scenario probably is not the end of the world for you, is it? Not unless you have a ton of debt and your margin for error is razor thin. So just as the phrase over the last 20 years for interest rates has been “lower for longer”, you might be surprised to find that phrase flipped on its head for the next few years – “higher for longer”.
But even if rates do stay higher for longer, will they come down in a gradual fashion? The Fed thinks so in its forecast, but that has not happened historically. A recent Wall-Street Journal article used the metaphor “stairs on the way up and an elevator on the way down” when referring to the normal pattern for Fed rate increases and decreases. That has often been the pattern of the Fed because those higher rates often eventually tip the economy into recession and then they have to lower rates quickly to try and counteract that. So take a look at your finances to see how they would be affected by rates staying higher for longer, but also take a look at what happens if they eventually come down much faster than they came up.
Let’s talk about another scenario. What if the government can’t come to agreement on a budget for the fiscal year and we see a government shutdown? Chief Economists Brian Wesbury with First Trust does an excellent job analyzing this scenario in his September 18th market commentary. According to Wesbury, in the last 40 years, we have seen four government shutdowns, lasting a combined total of 91 days. What’s most interesting about his comments is that a recession occurred following only one of those instances, and Wesbury contends that it was tight money that threw us into a recession and not the shutdown itself. That a shutdown was happening alongside a recession instead of being the cause of the recession. That instance was a 4-day shutdown in 1990, and it was a relatively shallow recession. He also clarifies that our debt payments will still be made on time, so there’s no risk of default if we see a shutdown. Wesbury does predict a recession in 2024, but not as a result of a government shutdown.
You and I have seen shutdowns before, the most recent of which was in 2018. As you may remember, essential services continued, social security checks still went out, the mail kept running, and at the end of that shutdown, there was not a recession. Sometimes we see these words and it gets our anxiety up thinking about everything that could happen. So back to scenario planning if a government shutdown takes place, what would you do in the case of a government shutdown October 1st? Unless you are a government employee, maybe not much. It is even possible that a shutdown forces conversations about how to stop the trajectory of increased spending on government programs as a percentage of GDP (gross Domestic Product). According to Wesbury, the government’s budget in 1930 was 2% of GDP. It has risen to 22% of GDP. I feel like percentage of GDP is a much better way to analyze these numbers as the amount spent will obviously increase with inflation. As a percentage, the government is 10x more expensive as a share of the things that we produce as a country than it was nearly 100 years ago. It will be interesting to see if the cost of funding the government comes up as a topic in the next Republican debate.
Here’s a final scenario for you to close: what if you drop your phone and your screen shatters? At MBC/Foundation Bank, if you have our Foundation Benefits account and your cell phone bill is drafted out of that account, you’ve got up to a $400 benefit to fix or replace your phone. Isn’t it nice to have that piece of mind? But our benefits account includes much more than that. Learn more by visiting foundationbank.org/accounts, clicking on the chat button, or talking to your local branch. Terms and Conditions apply. We love providing financial solutions, and one of those solutions is this podcast. If you’ve found this podcast helpful, we hope you’ll subscribe to it in your favorite podcast app and share it on social media. And until our next episode, God bless you.
-President Chad P. Wilson, CFP
Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on September 25, 2023. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.