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WhatsApp Reddit US Federal Reserve Chairman Jerome Powell speaks at the Federal Reserve Board meeting, Wednesday, May 1, 2024. (Graham Sloan/Sipa USA) (Sipa via AP Images)
The Federal Reserve left interest rates unchanged at around 5.3%, but some economists expect rates to be cut, possibly later this year.
But a return to the ultra-low interest rates of just above zero of the past decade is unlikely, says Robert Triest, an economist at Northeastern University.
“My guess is that interest rates will be much lower than they were between the financial crisis and the end of the pandemic, but not as low,” said Triest, an economics professor and department chair at Northeastern University.
“My guess is that ultra-short interest rates will fall to just over 2.5%, roughly in line with what the Fed announces,” he said.
The Federal Reserve sets the federal funds rate, the interest rate that banks will lend to each other overnight to ensure they have enough reserves. The federal funds rate also influences other interest rates, such as those on Treasury bills and government bonds, as well as the interest rates that banks can offer on mortgages, account interest, car loans, etc.
By raising the federal funds rate, the Fed can try to cool an overheated economy by making borrowing more expensive and reducing demand. Similarly, by lowering interest rates, the Fed can try to stimulate the economy by making borrowing easier.
Professor Bob Triest says the era of ultra-low interest rates is likely over. Photo by Matthew Moduno/Northeastern University
On Wednesday, the Federal Reserve announced it would keep the federal funds rate unchanged at 5.5% from 5.25%.
The decision was expected by most economists, Triest said, but a 5.25% to 5.5% rate is a significant change from interest rates for most of the past two decades.
The federal funds rate hovered just above 0% from the 2008 financial crisis until 2016, then dropped back down to that level again during the pandemic. Mortgage rates generally rose a few percentage points, hovering between 3.7% and 5.2%. Savings rates fell from 0.01% to 0.10%.
Since February 2022, the central bank has raised the federal funds rate by more than 5 percentage points to combat inflation. A 30-year fixed-rate mortgage currently averages 7.22%, and some savings accounts are offering rates above 5%.
The Fed's decision to keep rates steady is also at a sharp contrast with expectations at the start of the year that it would cut rates six times since March.The Fed's preferred measure shows that inflation has fallen to 2.7% from a peak of 7.1% in 2021. But progress has appeared to stall recently as costs related to home, health and auto insurance continue to rise.
As a result, Federal Reserve Chairman Jerome Powell said Wednesday that the central bank will wait to cut interest rates until it sees more evidence of falling inflation.
“A lot of it is expectations management,” Triest says. “I think most Fed officials are pretty confident that inflation will continue to fall despite this temporary dip in the first quarter, but they're going to wait until they see that in the data. That's partly to reassure themselves, but mostly to reassure the public that they're fully committed to their 2% inflation target and aren't going to cut rates until they see that in the data.”
So if the Fed is managing expectations, what exactly are those expectations? There's a bit of a debate among economists about this.
“Was the period of ultra-low interest rates from 2007 until very recently an anomaly?” Triest asks rhetorically. “If so – if it was all an anomaly – then we would expect long-term interest rates to remain roughly at current levels, maybe even lower, but not by much.”
“Or were there more fundamental economic forces pushing down interest rates at that time?” Triest continues.
For example, slowing population growth in the U.S. and other developed countries is pushing down interest rates, Triest says, because slower growth in the working-age population reduces the need for new capital investment and therefore the demand to borrow to fund that new investment.
Meanwhile, Triest points out that the world is in the midst of an energy transition from fossil fuels to renewable energy and is working to reduce carbon emissions through the Paris Climate Agreement.
“That requires significant capital investment,” Triest said. “Capital investment increases the amount of debt issued, which tends to drive up interest rates.”
Overseeing all of this is the Fed.
“Unless there are signs of a recession and inflation is falling below the Fed's target, I would be surprised to see the Fed go below 2.5%,” Triest said. “I wouldn't be particularly surprised if the Fed stops cutting the fed funds rate below 2.5%. Maybe they stop at, say, 3%.”
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