The Fed recently raised rates, but interest rates fell in response.
This is something we see so often that I had to blog about it – to again allay some of the confusion about the Fed’s rate increases.
Rates are way up now, but recently they fell at least 1/8% AFTER the Fed announced the increase.
And here are some of the reasons why rates fell:
- Inflation Fighting. The rate increase was perceived as a successful effort to fight inflation – something that has been pushing rates up more than anything else in recent months. So – successful efforts to fend off inflation give comfort to bond and mortgage investors, which results in lower rates.
- Short-Term Rate Only. The Fed raised the “Fed Funds Rate” which is a very short-term rate (overnight rate that banks pay) only. And, increases in the Fed Funds Rate don’t always result in increases in long-term rates, e.g. 10 Year Treasuries or 30-Year mortgages.
- Recession Expected. Rates also may have fallen because investors expect a recession. Recessions result in lower rates for a few reasons: (1) overall demand falls in recessions and that reduces inflationary pressures; and (2) the Fed tries to push rates down when recessions hit to stimulate the economy.
- Inverted Yield Curve. This is almost a repeat of the above, but when we see short-term rates higher than long-term rates (like we are seeing today), a recession almost always follows. In a healthy economy, long-term rates should always be higher because longer borrowing periods mean more risk. But, in a weak economy, investors perceive the long-term outlook as poor – so they move from stocks to bonds, pushing long-term rates lower than short-term rates.
- Market/Investors Expected Rate Increase. Another reason rates fell is because investors expected the increase in the Fed Funds Rate and had already accounted for it with their investment decisions and bond pricing. As a result, rates did not move much at all in response to the rate increase.
Rates Have Not Been This High Since 2019
The above heading is paraphrased from a WSJ headline from last week. It is also a reminder that, while rates have climbed significantly, they remain extremely low by historical standards and are not “that high.” We simply were spoiled by the extraordinarily low rates that the COVID crisis brought on.
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