Limbo Rates

July 29th,  it was announced that the Fed is considering cutting interest rates. Today’s Fed Funds rate is 2.4%. This is the rate banks charge each other for short term loans. The prime interest rate, from which consumer rates are scaled is 5.5% currently. The best fixed mortgage rates are less than 4%.

The Federal Reserve is charged with studying the economy and shaping interest rates which will spur economic activity. They raise or lower rates to either stimulate the economy or to cool it off before inflation becomes a problem. If you look at the history of Fed Funds rates since 1954, we are near the historical lows of less than 1% which helped get us out of the 2008 recession.

Low rates are great for borrowers and home buyers. Low rates help businesses to grow and finance operations. Low rates are detrimental to fixed income investors as yield diminishes. So the Fed must juggle a number of competing demands.

Despite the giddiness of the current administration, the economic cycle has not been repealed. There will be another recession at some point. My concern is that these low current rates will hinder the ability of the Fed to ease rates to spur economic activity when that time comes. Battling recession usually demands a significant slashing of rates. A 2.4% Fed Funds rate leaves little room for that significant cut and will hinder the Fed’s ability to guide us out of the next slow down.

~John Poulson