The Fed has spoken. Chairman Jay Powell clearly declared victory over inflation at his annual Jackson Hole, Wyoming, press conference. The next direction for interest rates is down. The Fed appears to have done the impossible: reduced inflationary expectations without causing a steep recession and loss of jobs.
While inflation is not yet down to the Fed’s goal of 2%, it’s pretty obvious that the “expectations” of future inflation have dropped sharply. That gives the Fed room to cut interest rates in the near future — either by 25 basis points (i.e., one quarter of a percentage point) or by 50 basis points.
No one is saying — or wanting — prices to actually go DOWN. That would signal deflation, which typically occurs only as part of a steep recession. Getting control of inflation simply means prices stop rising at a rapid rate.
So even a “win” on inflation by the Fed will leave consumers paying far more for most goods than they paid a decade ago. Those olden days, and lower prices, are not coming back. The relief is in the knowledge that prices won’t continue to rise dramatically in the future.
That also doesn’t make current budgeting any easier for those living on fixed incomes. Since prices won’t drop, then wages must rise (or people must work longer hours) to get ahead. For retirees, that is an impossible ask. And for retirees with savings, their interest income will also drop since rates will decline on bank CDs and T-bills once inflation fears subside.
The Fed’s “victory” over inflation is mostly a triumph that will be felt in the future, as people can plan for their future needs without worrying about needing ever more money to just break even. That’s a valuable triumph. You don’t want to be living in Venezuela (283% inflation rate) or Zimbabwe (667% annual inflation rate!) where money loses value so quickly that it is treated like the veritable “hot potato” — something to exchange for goods immediately before prices rise.
Since the American dollar is the basis for much of the world’s trade, it’s especially important that it be respected as a store of value and a medium of exchange. The stability of the dollar (lack of inflation) is critical to not only your personal finances but also to the prosperity of the civilized world.
Impact on your finances
With that lesson in Economics 101 completed, the real issue is how this victory over inflation will impact your personal finances.
As I mentioned above, if you’re a saver, you’re about to see rates drop. A few months ago, the rate on six-month T-bills was just over 5.5%. When those T-bills mature in the coming weeks, your renewal rate will be closer to 4.75%. But at that rate, you’d still be far ahead of inflation, which is currently running around 3%. Just don’t plan on getting the same amount of interest dropping into your account at renewal time.
You could stretch out the maturity of your TreasuryDirect holdings. But longer-term rates are actually even lower, reflecting diminished fears of inflation. Two-year Treasury notes now yield less than 4%, down 25% in yield from nearly 5% just two months ago. Chicken money is still beating inflation, but that lead will diminish quickly in the months ahead.
On the other hand, if you’re looking to purchase a home or refinance your mortgage, the Fed’s confirmation that rates are heading down will make a big difference to mortgages. At just below 6.5%, the average rate on a 30-year mortgage is the lowest in 15 months. Mortgage servicers are gearing up for a refinancing rush.
If you’re considering a re-fi (or pushing your higher-rate home equity loan into a refinanced mortgage), you might start shopping lenders now — but hold off on locking in the rate! If the Fed does a series of rate cuts, you could see rates in the 5% area in the next few months.
The stock and bond markets are cheering the prospect of lower rates. Businesses will take this opportunity to refinance some of their higher-rate borrowings, cutting interest expense and potentially raising their profits. That’s good for highly leveraged companies, those with a lot of high-rate debt.
Of course, all of this good news could reverse if there are a few bad inflation numbers, or if the economy slows more than the Fed has anticipated. But in the meantime, the Fed deserves credit for managing through a very tricky situation. And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)
