Jan. 11, 2023

Anticipating The Fed's Retreat

The Federal Reserve's Interest Rate policy has been on life-support since this new century began. In these 22 years, the Fed has tried to raise interest rates four times, only to fail each time.

 

In 2001, after hiking rates, the Fed retreated in anticipation of the 2001 Recession. Again in 2007, rate cuts were in order as the economy fell into the 2008 Great Financial Crisis. Then in the most intriguing of all, in 2019, interest rate cuts became the order of the day, just ahead of the Covid-induced slowdown of 2020.

Once again, the Federal Reserve seeks to achieve a more moderate interest rate environment in which both savers and borrowers can receive a return on their financial transactions. And once again, the Fed is faced with massive opposition. Businesses have come to rely on cheap money as their primary financing option. After all, for 9 of the past 22 years, this economy has functioned on zero interest.

Each time the Fed tries to get off the dime, some extraneous event hits the economy, be it a recession, financial crisis, or Pandemic, which causes the fed to cut back to zero interest.

It's becoming a battle of wills, with the corporate and financial sectors firmly convinced that the Fed will retreat this time and cut rates back to zero.

The clash between the Fed and the Private Sector is getting personal, and the Fed feels embattled. Anyone who read the last minutes of the Fed's Open Market Committee could feel the underlying frustration on the part of the Fed. Several members noted that the markets don't believe they will stay the course and continue to hike interest rates.

And that's right. Markers are being laid on both sides of this line, with the Fed beginning to dig in its heels on one side and corporate Americans convinced that lower rates will prevail.

Yesterday I talked to a friend of mine, a real estate developer in Arizona. Dave noted that at least one of the major banks was "buying down" the interest rate on qualified mortgages. Interestingly, this was a Fed member bank, and I want to avoid getting them in trouble, so I won't mention their name. But this is an "in-your-face" acknowledgment that the Bank thinks rates are going much lower. There are rumors that home builders, car dealers, and others who provide long-term loans are also buying down interest rates.

Dealing with climbing interest rates is a phenomenon that has been around for a while. We've been here before. But only when interest rates were much higher. It began in the 1980s when interest rates were double-digit. Today, it started when rates were barely 4%, a level we used to consider "normal."

For all the businesses that have a large loan attached to their purchases: real estate, automobiles, appliances, computers, and so on, they need to be able to provide financing for their customers. Many of these large ticket items are purchased not based on the item's price but on the monthly payments required to pay for the debt. And any vendor who cannot provide low-cost financing cannot compete.

There are creative ways that the Realtor or Car Dealer can trade off price versus payments, but these higher interest rates are squeezing their flexibility.

It is all part of a three-sided transaction. The buyer would like to purchase, but only if they can afford the financing. The vendors are becoming increasingly anxious to make the sale. Their business's survival may depend on it. And the banks are constricted by their higher costs of funds. With the vendor and or the Bank sometimes willing to "buy down" the prevailing interest rate.

Each group is trying to survive and prosper financially in this changing economic environment. It's the thing that happens when a couple of dozen Fed Governors meet ten times a year to decide the most basic of all financial transactions, the interest rate.