When Doves Cry
Sorry Prince but there are no doves crying today as the Fed turned dovish towards interest rates.
Last week, Fed Chairman Jerome Powell came across with the most succinct announcement of his tenure. The Fed was most likely done hiking rates and they expected to start drawing down rates next year. Possibly three times in 2024.
Of course there was some wiggle room but not much. It looks like the World ( or the US at the very least) is going back to normalcy.
Or so they say.
It always bugs me when they are going to normalize rates. That is such a subjective thing, normalcy. What is based on? If you look at the last ten years, it’s around 75BP. Roughly. If you look at it over the course of time, we are at that “Normal” interest rate. No need to cut, we built a nation on 3-4 % interest rates so what’s the hurry?
Most consumer borrowing is done at the micro level. Credit cards are most peoples debt accumulators. When rates were at .25%, credit card rates were roughly 16-25% depending on the card and your individual credit score. Rates went up to above 5% and credit card rates went to 17-28%. Yes, there was an increase but in relation to the Fed Funds rate, the increases weren’t all that significant.
Credit card companies have been roasting peoples nuts on the fire for decades so, other than mortgages, higher or lower interest rates are almost irrelevant in the bigger picture.
If you want to argue this, riddle me this Batman, when interest rates started dropping like a stone did credit card companies follow suit? No, they didn’t. They just had record earnings instead.
As you may recall from your Econ 101 class, credit card companies charge a much higher rate of interest than the Fed Funds rate because of costs associated with running the credit card business and they need ample cash for delinquencies on credit cards. Yeah, OK.
Do a little research on that load of horsecrap. Delinquencies on credit card balances have hovered in the 3 1/2 - 4% range for decades. The only major move was during the financial crisis of 2008. They skyrocketed to close to 7 %. With 2021 being the year where the delinquency rate was the lowest on record, did the credit card companies lower interest rates? No.
Visa, Mastercard and to a lesser extent, Discover, have been pillaging consumers for decades. The Huns had nothing on these guys and it will continue.
Interest rates will fall slowly next year but you will see zero change in the rates these companies charge their customers. This is one of the hidden sources of concern for a possible slow down next year.
Something to think about. You have had pretty much two years of wild consumer spending. Debt levels are rising for consumers to the point where people should actually worry. Consumers who charged like the Light Brigade will at some point have to start paying those credit card companies back. At 18% on $2000, it may not seem like much but that is money that is not going to be spent in the economy. Hence the slowdown.
They (Credit card companies) borrow at various times but they have never borrowed at 12 or 13% so the money they borrowed at 4 or 5% is still creating a hefty return at 18-25% for the consumer.
Rates come down next year so that will help mitigate the high interest rate pressure. Another load of BS. Consumer credit will remain at 18-25%. Trust me on this.
I don’t despise these companies for their business models. Just like I don’t despise loan sharks and their “Vig” either. They provide a service and have the breadth to provide that service across as many stakeholders as possible. That is capitalism and love it or not, it works.
Would I prefer to see something like a floating rate credit card? I think it could work and as rates fall, the interest rate on your balance would fall. And Vice Versa. The spread could be something competitive. Mortgage companies have doing this for a hundred years. Maybe it is already out there but the spread is egregious and no one other than people who can’t afford it in the first place use it.
I am no expert on the business of loans, credit and so forth. I am an expert on simplicity. Simple rate changes that are fair and also allow the credit card companies to make money seems doable. They could compete on the spread and everyone wins.
Simple.
Back to the drawing down on rates.
The Fed has indicated that they may cut rates back three times next year but those rate cuts may be just 25BP’s each and will that really have any impact on the economy as a whole? Not really.
The idea of a softer rate environment has lit a bit of a fire under investors seats and we have seen that overplayed “Santa Claus Rally” nonsense mentioned incessantly.
Yes, lower interest rates are better for investors, especially tech investors and yes, lower rates will help the housing sector as well.
However, rate cuts carry significance based on size.
25BP’s means the Fed is tweaking things and they are watching the data. 50BP’s means something a touch different. The Fed is concerned with the economic growth and their data points aren’t lining up where they want. 75BP’s or more means we are in freaking trouble. Someone screwed up and they need to make it right in a hurry.
Keep those numbers in mind next year as we see where things are going.
Keep this in mind and argue if you want but the Fed will work to get interest rates lower than the inflation rate and that will take a lot longer than the 12 months ahead.