Fed’s Interest Rate Cuts

This week, our Federal Reserve lowered the Fed Funds rate by ¼ percent. Fed funds are the money that banks lend to each other for overnight to meet reserve requirements. This rate is the key rate influencing other interest rates and, therefore, economic activity. However, this rate only directly affects short-term interest rates. Long-term interest rates include investor expectations for inflation.

If short-term interest rates are declining but investors believe that inflation may continue to be a problem, then long-term rates may actually trend higher. This is the paradox facing the Federal Reserve. To bring interest rates down across the board, they must be seen as still being vigilant against higher inflation. Doubts about this are the reason mortgage rates and other longer-term rates have not come down commensurate with the decline in the Fed Funds rate.

Inflation appears to be sticky around current levels. So, until that perception changes, do not expect longer-term rates to decline much at all. In fact, additional rate cuts by the Fed may make investors think that they are not being vigilant enough against inflation. Then long-term interest rates may increase. So, do not expect rates to change much from here. What we see is what we get. Stay steady my friends.

-The Lonely Bull