In poker, the “showdown” is a situation where, if more than one player remains after the last betting round, remaining players expose and compare their hands to determine the winner.
The showdown for interest rates occurred on August 23 in Wyoming – absent horses, cowboy hats, pistols, and booze.
The Jackson Hole Economic Symposium is an annual three-day international conference hosted by the Federal Reserve Bank of Kansas City at Jackson Hole, Wyoming.
The keynote speaker is the Chair of the Federal Reserve Board of Governors (the leader of the Fed), whose comments typically focus on the US economy and monetary policy.
This year, Fed Chair Powell played the interest rate showdown during his Jackson Hole speech, when he said:
- “my confidence has grown that inflation is on a sustainable path back to 2%”
- “we (the Fed) do not seek or welcome further cooling in the labor market”
- “the time has come for (interest rate) policy to adjust”
What gives the Fed Chair such confidence? Pandemic-driven inflation peaked at 9% in 2022, but has declined since, and recent readings show inflation has dropped below 3%.
The chart below shows the Consumer Price Index since 1965. According to this data series, inflation had ticked down to 2.9% in July.
Source: New York Times
Along with inflation, the jobs market has cooled, too – meaning jobs are still available, but harder to find now than a year ago.
Borrowing costs at their current level may be unnecessarily high, pressing down too much on the economy and inflation. Concerns about the possibility of an economic slowdown are likely behind the Fed’s signaling of future interest rate reductions.
So, the parlor game played by Wall Street people, where prognosticators pontificated and professionals speculated on the direction of interest rates, ended with the Jackson Hole speech.
What’s important to bear in mind is that the Fed has direct control over the overnight cost of funding for big banks (the Fed Funds rate) which is a very short-term interest rate.
The Fed Funds rate then affects other interest rates, such as the Prime Rate, which sets the cost of borrowing for consumers.
Currently, the Fed Funds target rate is 5.25% – 5.5%, and the Prime rate, which is usually about 3 percentage points higher than the Fed Funds target rate, is 8.5%.
The decline in short-term interest rates will begin soon, and most likely on September 18, when the Federal Reserve concludes its next board meeting.
Fed Funds futures contracts are financial instruments which allow Wall Street traders to speculate on what the Fed Funds target rate will be next month, or next year.
Fed Fund futures now anticipate a steady decline in short-term interest rates during the next 15 months.
These contracts currently anticipate Fed Funds declining in September, continuing to fall during the next sixteen months, and dropping by 2 percentage points from today’s level, to around 3.5% by the end of 2025.
What does this mean for Main Street people?
- It will get cheaper to borrow money (mortgage rates have already started to drop)
- “Safe” returns from CDs and High Yield savings accounts will start to come down
- Lower interest rates should provide a tailwind for stocks
Fixed rate mortgages have already begun to decline. The average 30-year mortgage was over 8% in late 2023. Today the mortgage rate sits at 6.5%. As short-term rates and the Prime Rate fall, it’s reasonable to expect that mortgage rates will continue to decline, too.
For savers, there is likely limited time to earn 5%+ yields on CDs, High Yield savings, and Money Market accounts. If you’re counting on that income to meet expenses, you should expect to receive less of it in the months ahead.
Since short-term rate declines should proceed at a measured pace, short-term yields above 4% should be around for a bit longer. But expect those yields to fall below 4% by the end of 2025.
For stockholders, the impending interest rate declines should be beneficial. Typically, a Fed easing cycle is a tailwind for stocks when the economy is growing (no recession, like today’s environment) at the time of the first rate cut.
The chart below shows that on average, stocks have significant gains during the year after the Federal Reserve reduces interest rates.
Source: Edward Jones
The chart measures time along the horizontal axis in weeks prior to and following the first “Fed cut”, or reduction in short-term interest rates by the Federal Reserve.
Stock market performance has been much less satisfactory when interest rates are declining during recessionary times.
-RK