August 31, 2020
Last week Jerome Powell, the Chair of the Federal Reserve, made two small, but very significant, policy changes. Orion realizes that many of our broker clients have their heads buried in working on loans. But it is also important that they know what is happening with interest rates, especially current developments.
Historically, when the unemployment rate got too low, the Fed would preemptively raise rates to reduce potential inflationary pressures. Even though inflation has not been a problem for decades, just the thought of it sends investors in fixed-income securities into a tizzy. There is a “healthy” amount of inflation, thought to be around 2 percent. Think of a retired individual who receives $2,000 per month, and spends $500 (25 percent) on food. If the same amount of food goes up $600 next year due to inflation, now that person is spending 30 percent of their income on food, leaving less money for other expenditures.
When the Federal Reserve preemptively raises rates to reduce inflation when unemployment drops, borrowing costs increase and companies are slightly less likely to borrow to expand. Our brokers should know that behind the Fed’s new thinking is an ailing economy (caused by the pandemic) and a stubbornly low inflation rate, below the healthy 2 percent, that has long defied the Fed’s efforts to raise it. The policy change reminds us of the Fed’s belief that an exceedingly low jobless rate is critically important for the economy and for individual Americans and that it should focus its efforts on achieving it. Now, the Fed will let the rate fall until inflation becomes too high.
Our brokers should know that the 2% inflation target can now be overshot for some time and is not a hard cap. Powell made clear that the policy change reflects the reality that high inflation (once a big threat to the economy) no longer appears to pose a serious danger, even when unemployment is low and the economy is growing strongly. It seems that the economy has changed in a way that allows the Fed to keep rates much lower than it otherwise would without igniting price pressures.
So we can expect rates stay lower for even longer! Good news indeed for Orion’s brokers and their clients!