Yes, Virginia, Interest Rates Will Go Down in 2024
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Yes, Virginia, Interest Rates Will Come Down in 2024
This past week’s Consumer Price Index (CPI) report showed inflation coming in at a 3.1% annualized rate in November, which is certainly welcome news to policymakers, economists, and borrowers alike. Runaway inflation has been tamed, we are on a course back to a normalized inflation rate of 2.0%, and as of now, there has not been an overly detrimental hit to the labor market.
Fed Chairman Jerome Powell should have a better Christmas this year than last, as the path to a soft landing has widened considerably. Albeit in his typically measured and moderate way, the Fed Chair was actually a bit optimistic this past week, saying:
I have always felt since the beginning that there was a possibility because of the unusual situation [due to the pandemic] that the economy could cool off in a way that enabled inflation to come down without the kind of large job losses that have been associated with high inflation and tightening cycles. So far that’s what we’re seeing…This result is not guaranteed. It is far too early to declare victory and there are certainly risks.
What Happens Now
After a grueling two-year cycle of interest rate hikes that saw the average 30-year fixed rate mortgage rate go from a low-point or 2.65% in January 2021 to nearly 8.00% this past fall, with commercial rates typically rising by 400 basis points or more (in layman’s terms, from around 4.50% to around 8.50% for an average-qualified commercial borrower), hope is in sight that rates will start dropping in 2024. This hope is well-founded.
Why? For starters, the Fed has been fighting inflation hard for the past 2+ years. If it keeps interest rates high for too long, however, it could choke off economic activity (i. fewer people will buy homes or vehicles, businesses will not finance expansions, etc.) While that would actually serve to ratchet down inflation even further, the Fed actually has a dual mandate to control inflation and promote full employment. If inflation is 0.0% but unemployment is 10%, the Fed has not done its job. To summarize where we are at right now, after hammering inflation with higher rates for two years, the Fed now needs to ease back on the throttle to avoid tipping the nose of the plane headfirst into the runway.
The Federal Open Market Committee Members Report from this past week projects three interest rate cuts of 0.25% each in 2024. The chart below via CME FedWatch, which is a report I closely follow, matches this projection. Right now, the Fed’s target interest rate rate range for the Fed Funds rate is 5.25-5.50%. By the 1/31/2024 Fed meeting date, market prognosticators give an 81.4% probability that the Fed maintains this range and an 18.% probability the Fed calls for an easing of rates downward by this point. Fascinatingly there is no one predicting further rate hikes by January or anytime afterwards. By the March meeting, there is a 63.8% chance of a rate decline, and a 13.4% of a more meaningful decline with still no one predicting rate increases.
By this time next year, there is a significant likelihood that the Federal Funds target rate will have dropped from a range of 5.25-5.50% to 3.50-4.25%. That will provide significant relief to borrowers and battered sectors that depend on low interest rates especially those connected to real estate. Presented another way, the CME FedWatch Tool suggests 100% certainty that interest rates will have dropped by June with no signs that there is a resurgence in rates later in the year.
The Caveat and Final Thoughts
Certainly anything can happen, and it is worth a moment’s pause to reflect on what a period of falling interest rates might also represent (besides just more advantageous borrowing). Interest rates typically are brought down in order to provide some relief to a questionable economy. Lower rates provide the economy with some needed juice in the face of economic storm clouds. So rates that decline due to a worsening economy are not necessarily a good thing.
Personally speaking, for awhile I believed the economy would need to be more battered than it has been for inflation to truly decline. This battering has not really taken place at least to the extent initially anticipated. But we don’t know what the future holds. The impact from one economic event may not be felt for months or even years later; there are always unanticipated consequences. And the unanticipated consequences of prolonged period of sharply rising rates may be an economy that finds itself in peril. The Fed may need to race itself back down to keep ahead of a rapidly cooling economy if it is not careful. The pendulum always swings.
For now, however, we should be optimistic. Not just because this is meant to be a positive and joyous time of year, but because many of the key metrics in our economy are actually doing quite well. Of particular note in this past week’s inflation report, energy prices are down 5% year-over-year with fuel oil being down a whopping 25%. That represents real relief for a lot of consumers struggling to pay their bills. And while the stock market is not necessarily a metric of the financial well-being of the average American or an indicator of the health of the overall economy, markets popped on Wednesday at 2:00 pm as they digested the Fed’s latest report and public statements from Fed officials. Markets are at or near all-time highs, which for a period of time when a lot of people still feel apprehensive about the economy, is both good news for the investor class and more-than-a-bit thought provoking.
I will have more thoughts on all of this in terms of how a drop in rates will impact real estate prices and rents in 2024. I typically do a rental market preview and a housing preview in January, which I plan to do again to kick off 2024. So stay tuned for that. As always, thank you for reading The Sunday Morning Post.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.