Rejoice! Inflation Is Down and History Is Made as the Fed Stopped Trying to Kill the Economy!

Perhaps there is no subject with a wider gap between its immense importance and the sheer boredom it induces than monetary policy. It’s literally the price of money, but if I wrote a more sober headline of “Fed cuts 50 basis points and expects another 150 basis points of cuts by next year” then no one would click on this and I wouldn’t blame you. I know this because I already ran this experiment back at Paste Business in 2016 and I set all time internet records for least clicked articles every time I wrote about the Federal Reserve.

But then the hot inflation print of November 2021 changed the world, the Fed hiked interest rates at one of the fastest paces ever, the rent got too damn high, everything became more expensive, inflation rose to the level of front-page news, and I got a Master’s in Finance in between, so you really can’t get rid of my nerdiness now that it’s useful to help explain one of the most important issues facing Americans today.

Which brings us to today, a historic day in this new world with the highest interest rates in two decades.

They’re coming down! And they will continue to come down until the Fed sees an uptick in inflation that worries them, or they hit their target where they plan to stop cutting. This means that borrowing costs for nearly everything will fall too. The basic dynamic behind monetary policy is that you lower interest rates to help borrowers and hurt savers to make people invest in the economy, and you raise them to do the opposite (which is why CEO of Ritholtz Wealth Josh Brown says that rich people actually love high interest rates because of the risk-free profit they get on their big piles of cash).

My title is hyperbolic, but it’s not an inaccurate description of the Fed’s goal since late 2021. The 1970s and 80s proved that if you raise interest rates, that will slow down the economy, and thus bring inflation down along with it. The Fed wanted to see the economy weaken, which it did, and the pain of high interest rates many have felt these past few years is a deliberate policy choice. They also wanted the labor market to cool off too, and Fed Chair Jerome Powell today said, “the labor market is not a source of elevated inflationary pressures,” so their war on workers seems to have ended as the Fed believes “inflation is…moving sustainably towards two percent.”

Another big reason that normal everyday people should care about this historic development, especially those who have or want a mortgage, can be explained in this chart below. The Fed Funds Rate is in red, and Freddie Mac’s 30-Year Fixed Mortgage Average in the United States is in blue, and you can see how closely correlated they are. The red line has peaked, mortgage rates are the lowest in 19 months, and the blue line will follow the red one downward over the next couple of years.

Chart per TradingView

What’s Next?

The 50-basis point cut was a mild surprise (50 basis points = 0.5 percent), as the standard minimum of 25-basis points was the betting favorite, which indicates that the Fed is a bit worried about the unemployment rate and how much work they did to squash the economy these past few years. Yields on most Treasury Notes rose a fair amount, which is the opposite trend of what you would expect with declining interest rates, and the Fed saw its first dissent from a governor since 2005 who voted for a 25-basis point cut today–so things are still nervy, and we definitely are not out of the woods yet.

The dot plot, which indicates each Fed officials’ expectations of the future Fed Funds Rate listed on the right side of the chart, suggests that everyone but two expect rates to be at or above three percent by the end of next year, with the expectation for long-run rates to settle somewhere between 2.25 and 3.75 percent, well below the 5.4 percent Fed Funds Rate we entered today with.

Image via the Federal Reserve

Dragging rates that low again would do a lot to help boost the economy, as debt would be cheaper to take on. There is plenty of data indicating that not only businesses, but regular everyday Americans have room to add additional debt in areas like home equity loans where people’s houses have increased in value, but they have yet to borrow against it and tap into that gain.

We are in a bit of uncharted territory here. The doomers at places that don’t understand the bond market like Zerohedge like to point to most Fed cuts in history coinciding with recessions, but this is a bit of a chicken and the egg question. Each hiking and easing cycle is unique to the economic conditions it unfolds in, and a lot of previous cuts have been forced by crashing economies, like in 2008.

This is not that.

The so-called “soft landing” where the Fed tries to squash the economy without causing a recession has been achieved before in 1994, and we may be looking at another situation like it, although opening with a slightly aggressive cut has sent some shivers down the market’s spine that there may be some trouble under the hood of our economic engine. Job growth has slowed dramatically, but that’s what the Fed wanted, so it would not be unreasonable to expect it to pick back up now that the Fed has changed its policy. Anecdotally, I have already heard of one person having a job they previously applied to reaching out after the Fed’s meeting today.

It is far too early to make any conclusions about how the economy will digest this pivot, and monetary policy has long, lagging effects, so we may not see today’s huge shift actually show up in the data for a year or more.

But in a pivot like this, the direction of Fed policy can be as important for the economy as the magnitude of it. A 50-basis point cut today may not directly make an impact until next year, but the expectation of more cuts at most Fed meetings the rest of the way can induce more spending since people see borrowing costs coming down in the near future. Sectors like housing could loosen up a bit as folks know that they can always refinance for a lower rate in the coming years.

The Wall Street Journal highlighted how business equipment could see a boost too, as a lot of that is purchased with long term debt that just got cheaper. They spoke to Dan McManamon, chief financial officer at Ohio Machinery, who said his business has delayed purchasing equipment for themselves and that “We’ve had people who say they’re going to buy, they’re just waiting [on the rate cut].”

Which has arrived, marking a new paradigm in our economy. Where this takes us is anyone’s guess, as the conditions we will see going forward will be wholly unlike what we have experienced the past few years. The labor market is still a concern, and housing inequality still has structural issues that cannot be solved by interest rates, but one thing is for certain: borrowing is cheaper for everyone today than it was yesterday, and barring an unexpected surge in inflation, that should be true after most Federal Reserve meetings until the end of 2026.