Last week started on a downward trajectory, before a huge recovery on Friday after Jerome Powell’s speech. He’s the President of the Federal Reserve Bank Board of Governors, and his talk from Jackson Hole seems to indicate that they’ll be cutting interest rates soon. The markets have priced in two rate cuts this year, with each cut lowering the Federal Funds Rate by 0.25%.
Which begs the question, what the heck is the Federal Funds Rate, and why does that matter? Most of the money you deposit in the bank has been lent out – on credit cards, car loans, mortgages, etc. Banks are required to keep a certain amount in reserve to process customer withdrawals. That number changes every night based on money flows that day. To meet the regulatory requirement, banks with more money than they need lend money overnight to banks that are short.
The Federal Reserve Bank, commonly known as “the Fed”, is known as the lender of last resort. If a bank can’t borrow what it needs overnight from other banks, it can borrow from the Fed. The Federal Funds Rate is the target rate for these overnight loans. Banks use that rate as the basis for the Prime Rate- which determines the interest rates that banks charge for loans.
When interest rates go down, businesses save money on interest, which means they can either put that money to use in the business – increased hiring, research and development, marketing – or they can pay out profits to shareholders in the form of dividends. Some companies may purchase their own stock, called a stock buyback or repurchase. It’s a sign that the firm’s management believes the company’s stock price will increase. All this to say, an interest rate cut generally drives stock prices up.
And while rates have not been cut yet, remember that stocks and bonds are priced at what the market believes the price will be in the future. Professional money managers are like Wayne Gretzky, skating to where the puck will be, not where it is now.
And the even bigger question becomes: why aren’t mortgage rates going down? Mortgage rates are not based on the Fed Funds Rate. Residential mortgages are based on the 10-year Treasury yield. That’s a bond issued by the federal government with repayment in 10 years. That’s partly because, while most mortgages are 30-year loans, the average lifespan of one is closer to 12 years.
The good news is that mortgages are slowly starting to come down, with the most recent rates for a conventional 30-year mortgage as low as 6.25%. The long-term average rate for a mortgage in the US is about 7.7%, so while rates feel high, they are actually cheap on a historical basis.
Your action item this week is to start decluttering. The tax law changes for charitable donations next year, including thrift store donations. Start with one drawer, one cabinet, one closet a week. You’ve got four months to collect all the unnecessary stuff in your house and donate it.
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