The Federal Reserve (FED) cut rates by 50 basis points in September—great news! However, as always, they struck a cautious tone, emphasizing that the fight against inflation is not yet over. The FED reiterated that their actions will continue to be data-driven in the coming months. They’ve also outlined a base-case scenario of two more cuts in 2024 (likely post-election in November and December), four cuts in 2025, and two additional cuts in 2026, bringing the neutral rate to approximately 2.9%.
According to an analysis by Yahoo Finance, the FED’s actions are being closely monitored, and further large cuts may be necessary to keep inflation in check (Why the Fed may need another jumbo rate cut). This could become a factor as the FED navigates economic challenges in the coming months.
If we do the math, eight cuts at 0.25% each amount to a total reduction of 2% over roughly 1.5 years. This projection assumes a “soft landing” or no major recession. However, if there is real softness in the labor market—such as rising unemployment—the FED may have an incentive to cut rates more quickly and more significantly.
Post-Election Freedoms and Economic Drivers
After the 2024 election, political pressure will ease, allowing the FED to act more freely based on the data at hand. Many banks are also in desperate need of lower rates on demand deposits, savings, and money market accounts to improve profitability. Furthermore, a substantial volume of maturing real estate and other loans needs to be rolled over or renewed. These loans cannot be renewed at current high rates as they fail Debt Service Coverage Ratio (DSCR) tests—a direct consequence of the Zero Interest Rate Policy (ZIRP) that the FED maintained for years.
Although it’s unlikely that we will return to zero interest rates anytime soon, moving closer to the neutral rate is necessary. The FED acknowledges this and will be watching the data closely to support the thesis that current interest rates are too restrictive and need to be lowered.
Housing Shortage and the Need for Lower Rates
Housing Shortage and the Need for Lower Rates
The United States is facing a massive housing shortage, particularly in the affordable housing sector. With “higher for longer” interest rates, construction starts have dramatically decreased. For the housing market to rebound and meet demand, lower rates will be essential to incentivize more development.
Moreover, the nation’s national debt is creating further complications. Interest payments on this debt now exceed the country’s defense spending, putting additional strain on government finances. Lowering interest rates would help ease the burden of these debt service payments.
A Likely Acceleration in Rate Cuts
There are numerous incentives for the FED to accelerate rate cuts once we are past the election and if economic conditions, particularly the labor market, weaken. The fundamental drivers of inflation seem to have passed, and rates need to be normalized sooner rather than later for the U.S. economy to function effectively.
We’ll have to wait and see where the economy goes from here, but I am in the camp that the FED will move more quickly with rate cuts once we are past the election and economic deceleration becomes a more significant concern.
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Source:
The original article referenced for some insights into the FED’s approach can be found on Yahoo Finance: Why the Fed may need another jumbo rate cut (https://finance.yahoo.com/video/why-fed-may-another-jumbo-135807877.html).
