President Trump is actively calling for the Fed to cut rates to 1%, as this Kobeissi Letter post on X explains, despite record-high asset prices and debt levels.
And, as per usual, all too many believe that massive cuts in the Fed Funds Rate will not only be effective, but that the cuts will foster an economic boom.
When I see posts on X demanding that the Fed cut rates to save the world, I think”…awe man, do I have to beat this dead horse again?” Apparently, I do.
Trump is demanding that the Fed cut the Fed Funds Rate to 1% (from its current effective rate of 4.33%).
But, I want to remind everyone that the Fed Funds Rate is only a very short-term overnight lending rate that banks charge each other to borrow funds to meet “reserve requirements.”
The Fed Does Not Control Long-Term Rates or the “Long End of the Curve”
Last fall, the Fed cut the Fed Funds Rate by 1% and long-term/mortgage rates INCREASED by 1% in response, as I remind readers often.
Why Mortgage Rates Went Up Last Fall After the Fed Cut
Long-term rates did not drop with the Fed Funds Rate for several reasons per analysts: (1) inflation was a much bigger concern – with hot inflation reports continuing to surface; (2) the labor market appeared to be strong, as we kept getting strong BLS jobs reports; and (3) the yield curve was inverted.
Mortgage rates will likely fall if the Fed cuts this time because inflation is a lot cooler (Core PCE has averaged 1.6% over the last 6 months), and the labor market is showing signs of weakness as well.
But, the effective Fed Funds Rate is 4.33% today. So, while small cuts are likely to help long-term rates, a cut all the way to 1% (like Trump wants) could actually push long-term rates higher.
This is because a Fed Funds Rate below the inflation rate is considered “inflationary.”
In any case, here is the biggest reminder and irony:
Bond Investors influence long-term interest rates much more than the Fed – and they look at two things: (1) inflation prospects; and (2) economic growth prospects.
IRONY: If a 1% Fed Funds Rate actually does result in sub-4% mortgage rates, it will be because bond investors believe Mr. Trump’s economy is tanking or is likely to tank.
Someone might want to tell Mr. Trump…
In a strong and growing economy, long-term rates will almost always be higher.
