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The Fed's Ace In The Hole Is Current Interest Rates

The Fed's Ace In The Hole Is Current Interest Rates

February 19, 2024

No matter how you slice it, the U.S. economy is humming along just fine. The rise in interest rates to combat inflation during 2022 and 2023 has appeared to be an effective tool to lower prices and avoid an economic slowdown, which was feared to spark a recession. Employment, consumer spending, personal income, and inflation-adjusted wages have all risen sharply in recent months.

Despite the higher interest rates, which have been with us since 2022, the GDP for the 4th quarter was 3.3%. For 2023, the GDP growth was 3.1%. The objective of the Fed was to try and maneuver a “soft landing,” – which is what they appeared to have done to this point.  

Warning signs exist, however, in the form of future spending concerns. Total household debt climbed by $212 billion in the fourth quarter of 2023 to $17.5 trillion¹. Using credit to purchase unproductive goods or services will force sacrifices of future income to pay interest and principal of borrowed money already spent.
¹Source: New York Federal Reserve

The personal savings rate for December 2023 was 3.7%². Pre-Pandemic savings rate was over 5%. Unfortunately, it is estimated that one in four adults have no emergency savings. Almost half of U.S. Households have some savings but not enough to cover three months of living expenses.

 ²Source: U.S. Bureau of Economic Analysis


Are We In An Expansion Mode?

  The chart above describes the normal progression of an economic cycle, beginning with an expansion, then a peak, then a recession, then a trough, and then a circle back to the expansion phase again. In theory, the concept can be best understood from a familiar adage: “What goes up must come down.” The uncertainty of when it comes down or how much is similar to the risks of investing in the stock market – we know there are corrections and down years, but we don’t know when they will occur or how severe they will be.

 As of February 2024, we appear to be in “expansion” mode. If our current expansion began when the unemployment rate fell below 4 percent in late 2021, we are at least in the third year. Raising interest rates seems to have slowed inflation (1.7% in the 4th quarter) but did not stop the blistering pace of economic growth. As long as consumer spending continues to carry the heavy load of economic growth, unemployment should remain low, and wage increases should exceed inflation. And if some indicators foretell potential trouble brewing, the Fed has an Ace up their sleeves.


The Fed’s Ace in The Hole – Room To Lower Interest Rates 

The Fed Chairman Jerome Powell indicated last week (2/5/24) that the Fed will probably not lower interest rates in March of 2024. The lowering of interest rates is a monetary policy used by the Fed to stimulate the economy by lowering borrowing costs. But why would they? The economy has shown tremendous resiliency despite higher rates. The Fed can afford to delay lowering the rates until signs begin to indicate that the economy needs the rate cut. For instance, if a higher-than-expected unemployment report and corresponding lower spending data cause recession concerns, the Fed can systematically reduce interest rates without the danger of rising inflation that still lurks in the shadows today. In addition, lowering interest rates will have a positive impact on the struggling mortgage market as many potential homeowners have been on the sidelines waiting to purchase when the rates fall or sellers who feel more comfortable about giving up their low-interest rate mortgages.

 The Fed funds rate today is between 5.25 and 5.50%. To lower the rate eventually to 2%, there would be approximately twelve to fourteen quarter point decreases - A positive sign for the long-term economic outlook.

  Where To Invest?

 I feel that Long-Term investing is synonymous with disciplined investing. As a CPA for 36 years, I’ve focused on the academic evidence that overwhelmingly supports the financial benefit of letting the markets work for you, not against you. Making investment decisions based on fluctuations in business cycles is generally not part of a long-term investment strategy. Believe me, if a consistent method could predict stock prices by changes in the business cycle, we’d all be doing it. However, in today's environment, short-term interest rates are at least equal to or higher than the longer-term rates. There are planning opportunities that can be taken advantage of depending on your financial situation, your goals, and your risk tolerance. 

Please feel free to contact us at (925) 484-1671 or email us to set up a no-charge consultation or if you have a question about our services. 

Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful.