The Federal Reserve will release an edict decision Wednesday on interest rate policy. Everyone knows that they will make no change in rates, calling it a “pause” in policy, because countless Fed officials have already told that to various financial media outlets. There are people calling for the Federal Reserve to lower rates, and some are claiming that interest rates are too high. They aren’t. One can simply look at the fact that inflation has not gone away to know that. The most recent CPI reports, including yesterday’s, has shown that the rate of inflation has gone down from its heights of twelve months ago, but it is still much higher than it has been in years past.
There is an expectation, though, among stock market traders, that one day rates will go down dramatically like they were before 2021, but that’s not going to happen. Interest rates are not too high now, in fact they may not be high enough to truly solve the inflation problem. If you take a look at the history of interest rates though going back to World War II this zero rate policy was something only seen in recent years.
If you look at this chart, notice that interest rates were almost always above 2.5% until 2008. It wasn’t until 2008 that the Federal Reserve took rates down to zero and began it’s QE bond buying operations. They tried to “normalize” rates in 2018 and then backed off when the stock market faltered (remember Donald Trump yelling at Jerome Powell) and slashed them back down to zero in 2020. As a result, they reached a secular end point to the bond bull market that started in 1980, as interest rates had nowhere to go, but up from there. They were not going to go negative and could not once inflation began to accelerate. That inflation was the cost of the easy money policies that began since 1987 when Alan Greenspan reacted to the stock market crash – all they did was grow and accelerate over the years.
Interest rates at 5% are not really high when you look at the history of interest rates. In fact, one might call a 5% Fed Funds rate as normal and not exceptional. What was abnormal were rates at zero.
Remember that today if you see some people on CNBC call for rate cuts or Jim Cramer yell for them.
Interest rates are not too high.
Oh sure, they might be high for regional bank managers who bought Treasury bonds in 2020 when interest rates were zero.
They are stuck on those bonds now with losses, because they bought them at a dumb time when interest rates had no further to drop, because bond prices trade opposite to their yields.
Regional bank stocks crashed in March, because people suddenly realized that these banks made one of the stupidest financial bets one could make in the markets when they bought these bonds in 2020. They should lose their jobs, but so far only a few have and the Federal Reserve created an emergency lending program to help them in March.
Sure, at some point interest rates will be cut when the economy goes in recession or there is some other sudden blow-up in the financial system, but that doesn’t mean that they will be taken by down to zero when they are lowered. We aren’t going back to the way things were before 2021, so we’ll probably never see interest rates go down to zero in the rest of our lifetimes.
History shows that when rates are below 2% that giant financial bubbles are created that eventually cause disaster when they pop. I just watched an interesting conversation with Nicholas Taleb about interest rates, inflation, and the silliness of crypto that aired on Bloomberg. Check it out. He talks about how a big problem is there are a generation of investors who started to trade after 2008 (many starting in 2020) who don’t even know what interest rates are – they think that zero rates are normal, because that is what they entered the market seeing. Most of these people that started trading on Robinhood in 2020 have already blown themselves up, but they still remain financially illetarate.
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