LET'S STAY CONNECTED!

Rates are Where They Are… Now What?

Last week the Federal Reserve’s Open Market Committee, which sets the overnight Fed Funds rate, unanimously indicated that the 2 percent inflation rate target was a hard target and they will use the tools they have to reach it. Orion’s brokers know, however, that “the Fed” doesn’t set the price of oil, lettuce, electricity, beef, and so on. Can the Fed lower inflation?

Covid hit the world in early 2020 and, after the worldwide economy practically stops in early- mid-2020, the economy grows rapidly in recovery. Responding to the economic stoppage/slow down, the Fed reacted by cutting rates to near zero, and purchased assets to force rates down to stimulate the economy. With rates dropping to historic lows, housing markets exploded, and home prices spiked. At the same time, homeowners refinanced to rates and payments so low that they essentially become trapped in their houses, not being able to afford to sell and buy up, or down. By the end of 2020 the economy no longer needed stimulus as it was getting very “hot.” Extremely low rates and a growing economy leads to inflation rising steadily until it peaks in June 2022 at 7.2 percent.

Economists suggest that the Fed’s efforts to stimulate the economy and then to depress inflation seem to have had little to no impact. What can impact rates, especially longer-term maturity rates like mortgages, is the Fed purchasing hundreds of billions, or trillions, of dollars of U.S. Treasury debt and mortgages, thus influencing the demand for bonds and thus influencing the interest rate markets and forcing them down. They retained the assets, for some periods using proceeds from termed out, or paid off, bonds and mortgages, to purchase more of the same.

If the Fed sells off a large amount of Treasury bonds and mortgages, it instantly impacts interest rates, as opposed to raising and lowering its Fed funds rates, which has an indirect impact on rates, mostly by investors reacting to what may happen next. In addition, what we have seen is that pandemics, wars, tariffs, government spending, have a much greater impact on interest rates as these can create recessions (lower rates) or inflation (higher rates).

Most economists and investors believe that rates will continue to remain elevated for quite some time. The Federal Reserve’s Open Market has indicated that another rate hike next month. Mortgage rates will not drop significantly until inflation drops below 3.25 percent, possibly 3.0 percent. The primary factor that could cause this would be drop in oil and energy prices, which means are solution to the war with Iran, and/or a steady and dependable supply of oil in significant amounts to offset the lack of supply that would normally be flowing through the Strait of Hormuz.

Second would be a reduction in tariffs, in amount of cost and/or products impacted. Artificially raising prices, and/or restricting supply, which is the result of tariffs, not only increases the prices to consumers, but to manufacturers who depend on tariffed products for production. They must then raise prices, and/or cut production and labor.

It doesn’t take long to realize that controlling interest rates is pretty much impossible in a free market economy. Hedge fund giant Stanley Druckenmiller observed, “Governments defending prices against fundamentals always lose.” Instead, Orion and our brokers focus on consistently offering the best products and service to our clients, at competitive rates.

‍