What the Next 18 Months of Interest Rates Could Look Like
Trivia
This particular question is unrelated to today’s article, I’m just throwing this in to try something new. The trivia question is at the top here, with the answer at the bottom of today’s article underneath my footer.
Question: there are seventeen U.S. companies worth more than $500 billion, but only one of these is based on the East Coast. What is it?
What the Next 18 Months of Interest Rates Could Look Like
A commonly used phrase in these digital pages over the past few years has been, “Fed Chair Jerome Powell has a problem.” From steering the U.S. economy through the COVID-19 recession by slashing interest rates, to raising them to tame the ensuing inflation, and now attempting to strike a delicate balance between steadying rates and averting recession, Powell and the Federal Reserve have faced an unrelenting gauntlet. Add the persistent political pressure from a president who publicly clamors for rate cuts—and even threatens the Fed Chair’s job—and it’s clear: the last few years have been extraordinarily challenging for Powell.
I don’t think they do polling on approval ratings of Fed Chairs, but Powell and company have also felt the heat from an American people who, as is their custom, want two different and, at times, seemingly incompatible things: a low inflationary environment and a growing economy. The greatest challenge of all for the Fed over the past five years has been how to keep interest rates stable so that things don’t get overheated, but not too high that the economy doesn’t tip into a recession.
I was skeptical early on in this particular Fed regime that they had brought rates too low, for too long. In retrospect, I do think that was the case — it created a pandemic-era sugar high where money was too cheap for borrowing, and it led to tremendous growth, but also rapidly rising real estate prices and all sorts of negative unintended consequences. However, it is hard to prove a counterfactual, and the truth is, the U.S. economy held up remarkably well both during the pandemic and after. Without lowering interest rates the way they did, it is possible the economic fallout from the pandemic (i.e. from what world shutting down) would have been quiet devastating. Yet growth even through to today remains strong, inflation has mostly normalized, and the U.S. economy is, in general, outpacing the rest of the world.
But despite what the numbers suggest is a pretty good economy today (the economy grew at an annualized rate of 3% in Q2; unemployment is generally stable at 4.2%), people still feel worn out and wary. The latest University of Michigan consumer sentiment survey showed a decline this month over previous readings. America is hungry for interest rate cuts, and for the first time in a long time, this past week Chair Powell gave some life to the notion that, yes, interest rates are soon to come down. But which interest rates? And when? And how will it impact ordinary Americans and investors?
What Powell Said This Week
In remarks at a conference at Jackson Hole on Friday, Powell highlighted the uncertainties in the economy, saying:
This year, the economy has faced new challenges. Significantly higher tariffs across our trading partners are remaking the global trading system. Tighter immigration policy has led to an abrupt slowdown in labor force growth. Over the longer run, changes in tax, spending, and regulatory policies may also have important implications for economic growth and productivity. There is significant uncertainty about where all of these polices will eventually settle and what their lasting effects on the economy will be.
He also pointed risks in the labor market, which is marked by a slowing of both supply of workers and demand for workers:
Overall, while the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.
Powell also commented about how inflation is still a notch above where the Fed would like to see it, and that the impacts from tariffs “are now clearly visible,” and that “we expect those effects to accumulate over the coming months.” In other words, there is upside risks in inflation, in part, due to tariffs.
With all that in mind, on the question of interest rates, Powell said:
Putting the pieces together, what are the implications for monetary policy? In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate…Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.
Markets took the last statement above to be an indication that the Fed is now willing to budge in its hawkish take on interest rates, and may start bringing rates down as soon as next month. The Dow Jones Industrial Average spiked by 900 points after Powell’s comments, with other markets following suit.
So What’s Next for Rates?
Markets are now pricing in about a 75% chance of a quarter-point cut in the Fed’s key interest rates following their next meeting on September 17th. They are also pricing in a 50% chance of a second rate cut by the December meeting. Looking out ahead one year, markets predict rates will be about 100 basis points (i.e. one percentage point) lower this time next year than they are today, and perhaps 100-150 basis points lower by the end of 2026.
What it Means for Commercial Rates
On the commercial side, rate decreases are likely, as many commercial banks peg their loan pricing around key Federal Reserve rates; when those rates drop, so, too do commercial loan rates. For borrowers who have been used to seeing rates in the 7.5-8.5% range over the last year, they may see rates start to edge down this fall and perhaps be a full percentage point lower by this time next year. That will be welcome news to many, especially those who became particularly leveraged over the past few years and who may be facing interest rate resets on their commercial loans out of their initial 3- or 5-year fixed rate periods.
What it Means for Residential Rates
The question of home loan interest rates remains a bit more muddled. The pricing of home loans is complicated unfortunately, and is not based solely on what the Fed is doing. The main reason for that is that banks typically package their home loans for repurchase in private markets, and those markets have their own pricing mechanisms around supply and demand and predictions of future rates including the rate of inflation. If markets predict an inflationary period of time in the years to come, they won’t purchase, say, 4% mortgages from banks — they will demand 7-8%+ mortgages, which is where banks will have to price them. And long-term inflation expectations are still pretty uncertain. For this reason, it is likely that home mortgage rates will stay elevated for the foreseeable future, barring a major pullback in the economy and a more deflationary environment.
A Brief Comment on Black Swans
The term black swan refers to events that are impossible to foresee or predict because they are beyond our general understanding of what is possible. For centuries, everyone assumed all swans were white — that is, until black swans were discovered in Australia. That is where the term comes from. The term today generally is used in predicting the unpredictable, most often with regard to negative or catastrophic possibilities.
I’m not typically a black swan type of guy. It’s easy and trendy to make predictions, especially in a world where algorithms juice engagement around absurd and overconfident predictions (oftentimes there is no professional or personal consequence for being wrong in these predictions, by the way. The world just moves on). But I do have a lot of worries about what could happen to inflation next spring and in the months that follow, and that is because the Fed Chair’s term ends in May 2026.
The U.S. founders were geniuses, and the most important thing they did was to spread power out in the government. We have three separate branches of government — executive, legislative, and judicial — with checks and balances between them. But even beyond that, there is further decentralization of power woven into the fabric of the government. Just look at the Federal Reserve: its members are appointed by the President (executive), but confirmed by the Senate (legislative). It derives its power by virtue of being created by Congress (legislative), but the courts can rule on cases related to the Fed (judicial).
Regardless of your politics, one thing is pretty clear from the first half-year of the second Trump Presidency: he wants control over the entire government. The president cannot fire the Fed Chair (other than for impropriety or ethical reasons), but that hasn’t stopped Trump from saying things like, “Powell’s termination cannot come fast enough,” and, “If I want him out, he’ll be out of there real fast, believe me.” Earlier this summer, Trump threatened a lawsuit against Powell for allegedly mishandled renovations to the Federal Reserve building, which could potentially give Trump grounds to remove Powell for cause (this doesn’t really seem to be going anywhere, though).
But Powell’s four-year term ends in May 2026. At that time, Trump will appoint Powell’s successor. Trump has made no bones about his view that interest rates need to come down. Doing so would likely boost the economy in the short-term by giving a jolt to borrowing, which leads to expansions, acquisitions, and growth. This would likely be good for Trump politically, and help in next year’s mid-term elections.
But it can also lead to an overheated, sugar-high economy, which we saw aspects of from 2020-2023, for sure, and along with it, 7% inflation. I don’t think Trump has any respect for separation of powers, and he certainly doesn’t have much respect for any of the sort of limitations on executive authority that the Founders tried to enshrine in the U.S. Constitution. Trump is, in my opinion, therefore likely to appoint someone who will do his bidding to bring interest rates down, which may very likely juice the economy in the short-term, but potentially lead to a total resurgence of inflation along the lines from what we just, finally, are easing down.
I know it’s not a moment in time when people want to talk about such things as the norms of government (we’re in an era where the norms are being thrown out), but separation of powers and Fed independence matter an awful lot. I see real risks to not just the U.S. economy but the value of the dollar if some of these norms can be held intact, and if people lose confidence in the dollar, then you’ve got the makings of a true black swan event.
Truth be told, the President should act as a leader, cheerleader, and advocate for the U.S. economy. I don’t disagree with that, or begrudge Trump for wanting a strong and stable economy during his presidency. But the economy outlives the four-year term of any U.S. president, and for its long-term health, these dull and seemingly antiquated notions of agency independence and checks and balances within the government are crucial.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.
Trivia Question: there are seventeen U.S. companies worth more than $500 billion, but only one of these is based on the East Coast. What is it?
Answer: JPMorgan Chase. Almost all of the other seventeen companies worth more than a half trillion dollars are based in California. Other exceptions include Walmart (Bentonville, Arkansas), Tesla (Austin, Texas), Berkshire Hathaway (Omaha, Nebraska), and Eli Lilly (Indianapolis, Indiana). I believe the next company located on the East Coast is Home Depot, valued today at $411 billion and based in Atlanta, Georgia.
The credit for this question goes to the Acquired podcast interview with JPMorgan Chase CEO Jamie Diamon, which is a pretty good listen.
Have a great week, everybody!