FED Funds Rate decision for dummies, and how "It's a Wonderful Life" can teach what we need to know about modern day economics.
(5 Min read)
FOMC Meeting: Jay Powell & the Crew
Today "the Fed" will meet at 2 PM to decide wether or not to raise rates for the 10th meeting in a row. The fastest acceleration of interest rates ever.
The market has "priced in a 25 bps hike", meaning theres a high percentage this rate increase occurs. Putting the fed funds rate to 5-5.25% the highest it's been since 2007.
So what does this mean? (For Non-Finance regular humans)
All loans are tied to a "benchmark rate," In the US this is the FED Funds Rate.
The federal funds rate can be lowered by "the Fed" to encourage economic growth. Meaning, the normal banks (Bank of America, JP Morgan, etc) can now get money from the federal government for a lower interest rate, in turn are able to distribute this money to you and I for a low rate of interest. Allowing the average joe to get credit for less, leading to higher spending, larger investments, and more jobs. You get the point, lower rate = more spending money for us.
On the other hand, the Fed can do the opposite. Increasing the federal funds rate to slow down the economy. Meaning, it is now more expensive for normal banks to borrow money. Making, it more expensive for you & I to now borrow from these banks (Bank of America, JP Morgan, etc). Giving way to higher interest rates on loans for things like cars and houses. In turn, people begin to borrow less and the economy slows down. Higher rate = less spending money.
As the consumer you may be thinking the hell with high rates lets get us some more spending money. Well, theres a problem with that too. Enter....
With lower interest rates the result is almost always the same: a rise in demand for goods and services. Making prices & goods soar because people want them, leading to higher wages being demanded due to these higher costs of goods, and finally to the point where goods are stocked up on before it's too late due to prices increasing so much or supply was so low. Like the Covid-19 toilet paper fiasco the demand was so high, and supply so low, companies could charge whatever they wanted because people needed toilet paper in lockdown. It's an extreme case, but you get the point.. I hope.
The other side of the Coin..
Now you are probably assuming ok fine we need to increase rates since the last time you went to get eggs you had to re-finance the mortgage (kidding). Seriously, though inflation has hurt the American consumer badly in the past few months, and it is a rational deduction, raise rates so I can get some damn eggs. I get it, however, it's not so easy. Remember, Higher rates = Higher Cost of Borrowing.
When these rates do rise the smart investor becomes the Lender instead of the Borrow. Confusing, but basically the higher the cost of borrowing, the more money the lender can now make. And, you do not need to be a Bank to lend. The decent investor now uses what are called T-Bills to lend to the Government to pay off their debt.
So now, you have the ability to lend to the Government on a 5% yield. The yield being how much money you get from interest payments paid to you. Great remember, Fed Funds Rate is the benchmark for this yield, they control it. So, you are now receiving 5% on whatever amount you lend for theoretically no risk (unless the US Banking system collapsed, but you know we're all screwed anyway).
You may be thinking, no brainer take all my money and give me that 5%. Exactly, you are right. And, is exactly what's happening. Individuals, particularly wealthy, are moving their money out of depositors (Bank of America, JP Morgan, but specifically smaller regional banks) and into into Treasury Bills. If you have ever seen It's wonderful Life you should remember how banks work. They don't actually have the money on them in a safe. As George would say: "You're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others."
Meaning, if everyone goes to the Bank and ask's for their money to put into T-Bills (Mr. Potter), well then eventually these Banks (George) can no longer give any out, even though they technically owe it to you and I. This is what we call a Bank run. And, is why today is one of the most important days in recent Economic history. There have already been three major bank collapses with the previous Federal Fund Rate.
The question is what should the Fed pick? Inflation, so you can buy groceries reasonably, or the health of banks. They most likely raise rates however the fall-out of this decision, no one really knows.
It is no easy decision for the Fed today. But, one things for sure buckle up, because either way there will be consequences.