The Next Move in Interest Rates

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The Next Move in Interest Rates

The Federal Reserve sent a very clear signal last week that their benchmark Fed Funds rate has peaked and that they will begin lowering rates soon. Let me remind you what the Fed Funds rate is. It is the target rate at which banks lend to one another overnight. Some banks have more loan demand than deposit demand, and these banks might want to borrow from those banks who have just the opposite problem, more deposit demand than loan demand. So a bank with excess deposits can earn between about 5.25% and 5.5% on an almost risk free basis right now. The higher the Fed Fund rate, the less likely banks are to be aggressive in their lending. Why is this? Because they are getting a really good rate in Fed Funds on a nearly risk free basis. Why would they want to take risk on a loan that’s not going to pay them a dramatically higher rate? This can lead to what we call “tight money.” The less banks lend, the less money we see in the system. Well, the Fed has seen its preferred inflation gauge come down to the 2.5% range, so now it wants to make money less tight to prevent a recession. One of the ways they do this is by cutting the Federal Funds rate.

So the question is, will they cut in a gradual fashion? Let’s say .25% each meeting? Or will they cut more aggressively? Let’s say.50%. The Fed Funds Future’s market thinks there is a better than 50% chance the Fed cuts rates by .50% in its September meeting. My best guess is that the Fed moves gradually – .25% for this month. What does the level of the Fed Funds rate have to do with you? Well, the Fed Funds rate is most directly tied to the Prime rate. This is one of the primary rates used for commercial borrowing. So businesses are likely to benefit from a gradually reducing cost of borrowing over the next couple of years as the Fed Funds rate comes down. The Fed Funds rate is not directly tied to mortgage rates, but it does have an indirect effect. Mortgage rates are more tied to the 10-year treasury bond. The 10-year treasury bond is often determined by prospects for economic growth as well as inflation expectations. Regardless of what affects mortgage rates, you are probably wondering if lower mortgage rates are likely. Yes. But I think it’s unlikely that we will ever see the 2% and 3% rates we saw pre-Covid. Just as Baby Boomers tell their kids that they once had mortgages in the 12% range, Gen Xers and Millennials will tell their kids that they once had a mortgage in the 3% range. Those rates were artificially induced and occurred during the days of low inflation and globalization. I’ve made the case in previous episodes that I think those days are behind us. My best guess is that mortgages eventually settle into a 5-6% range for the next several years. But for now, many families have no plans to move, because they have those low-rate mortgages, and a move would cost them a lot more money.

Well, the Fed is walking a tightrope as they reduce rates. They want to lower rates enough to avoid a recession. But they don’t want to lower rates too quickly and ignite inflation. That’s a difficult task and the Fed has not been good at that, historically.  If interest rates seem to have peaked for this cycle, what are some decisions you can make?

Lock in a portion of your fixed rate investments for as long as you can. Whether it is a CD or a bond, or a fixed annuity, try to lock your rate as long as you can on a sleeve of your money. You will notice that the best rates on CD’s currently are for shorter maturities – maybe 5 months, 7 months or 9 months. That’s because banks are anticipating a lower rate environment. If these rates eventually end up settling into the 3% range, you will wish that you would have locked in 5% when you could for as long as you could. Your future “you” will thank you. Most people do 1-year CD’s and just keep rolling them over year after year. But there are alternatives and there may be some value to locking in those alternatives for a longer period of time. We happen to have several 5-year fixed annuities our investment area offers that are earning 5%. Now, fixed annuities are not FDIC insured, but they do have a place for certain investors.

Consider laddering your maturities. Rather than putting everything coming due in 5-years or longer, even if you think you know what interest rates are going to do, ladder some of your money to come due in 1-year, some in 2-years, some in 3-years and so forth. As confident as we all seem to be that interest rates will go down, laddering your maturities is an “all-weather approach” that can allow something in your fixed investment portfolio to be winning at all times and give you an opportunity to have money coming due at all times. Laddering takes the guessing out of what interest rates are going to do, and it’s a time-tested strategy that can serve you well.

If you are a business thinking about borrowing money to expand, you might press the pause button. Don’t put your idea on the shelf, but you might just enter a period of observation and cash building for two reasons. If we do have a recession, you’ll be in a much better position to seize opportunity having a strong cash position. It’s also possible your borrowing costs will be less in a lower rate environment. So there might be some benefit to going ahead and getting your ducks in a row, but not pulling the trigger just yet.

At Foundation Bank and MBC, we help clients with these decisions every day. If you want to hear more about whether a Fixed Annuity would be suitable for you, or if you want to talk through your latest idea to expand your business, we can help. We offer competent, careful, and compassionate perspective on your financial questions. Contact us by visiting foundationbank.org.  We also hope you’ll subscribe this podcast to it in your favorite podcast app and share it on social media. To be clear, we are not attorneys and this episode is not a recommendation specific to your own unique circumstances. Please consult your own legal advisor for guidance that pertains specifically to you. 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 Foundation Bank/McKenzie Banking Company on September 4, 2024. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. Any rates mentioned are subject to change and are accurate as of the recording date. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.