On average, when recessions hit, the Fed lowers the Fed Funds Rate by about 5%.
Currently, the effective Fed Funds Rate (the overnight lending rate between banks) is 5.33%.
So, if the Fed follows its normal course of procedures, we can expect the Fed to lower the Fed Funds Rate to almost zero when the next recession hits.
The Return of “ZIRP” (Zero Interest Rate Policy)
And – that is why so many analysts are predicting the “Return of ZIRP.” This also may be why the Fed was so hellbent on getting the Fed Funds Rate over 5.0% with its rate increases; they may have just wanted ample “rate-cutting ammo” to fire off when the recession hits.
As a reminder, ZIRP stands for Zero Interest Rate Policy. And if we get anywhere close to ZIRP, we can of course expect far lower mortgage rates – given that they dropped to the 3% range during our last round of ZIRP.
The Fed of course will be more apprehensive about returning to ZIRP, given the inflation scare we just endured. But depending on how bad the economy gets, they may not have a choice (I just would not count on it).
How Long Will ZIRP or Lower Rates Last?
Analysts constantly remind us that the U.S. economy is like a giant oil tanker that takes a long time to respond to course corrections.
When sh*t does hit the fan, Congress and the Fed will likely overreact – with stimulus spending and massive rate cuts.
And on average, it takes about 18 months for the economy to respond to rate cuts and stimulus.
In light of that, we can expect to enjoy about 18 months of lower rates and feeding frenzies in both refinance and purchase markets.
So, we should all be ready to make as much hay as possible while the low-rate sun shines, but we should also be ready for a return to current market conditions after the 18-month feeding frenzy.
Two Signs Sh*t Is about to Hit the Fan
There are numerous longer-term signs that the economy is going to soften. I mention them often, and they include: inverted yield curves, rising unemployment, banking system stress, credit defaults like we are seeing with commercial loans, credit card balance and default buildups, depletion of savings accounts, shrinking money supply, overseas recessions, declining consumer confidence, and falling leading economic indicators.
And, as I have also mentioned, the long-awaited recession has been delayed because: (1) consumers were able to draw down huge savings caches – largely from stimulus; (2) government spending and hiring has been off the charts and artificially elevating the economy; (3) consumers turned to credit cards to maintain spending habits; (4) employers have been “hoarding labor,” afraid to lay off because it is so hard to re-hire and train; and (5) wage gains amongst younger employees were allowing them to spend like there is no tomorrow, particularly when they still live with mom and dad.
But, per George Gammon, there are two sure signs things are getting real: (1) widening credit spreads; and (2) yield curve un-inversions.
Credit spreads are the difference in yields between corporate bonds and U.S. Treasuries. Corporate bonds have higher yields than Treasuries because they are not as safe, secure, or liquid. But when investors fear that the economy is going to soften, they demand higher yields for corporate bonds (especially lower-rated bonds) because the risk of default is higher. This happens at the same time that Treasury yields are falling, as investors pour into them for safety and security.
An inverted yield curve refers to a situation where long-term yields (rates) are lower than short-term yields. This is not normal because longer-term instruments should be riskier and command higher yields. So, inverted yield curves almost always signal a recession in the future.
When the yield curve returns to normal and un-inverts, with short-term rates becoming lower than long-term rates again, you will not want to be near a fan.
