The Macro Market Wrap Up With The Mad Genius, Vol. 20

Usually I like to talk about something that happened or a headline that grabbed my attention. Instead I am writing about something that is about to happen. That is the 2-day policy meeting taking place tomorrow and Wednesday at the Federal Reserve.

They’ll be discussing a lot and making decisions behind closed doors, but the big news to watch for is if the Fed will hike the interest rate on the Fed Target Rate by another quarter percent, or 25 basis point. And right now there’s about 75% chance that the Fed will hike interest rates.

Personally, I think the Fed is damned if they do and damned if they don’t. And I get it…0.25% ain’t a heck of a lot of interest. But remember that the Fed has been hiking rates since December 2015, and really began hiking in earnest in December 2016.

So here are the problems with hiking interest rates another 25 bps, or ¼ percent. First and foremost is that all other interest rates are tied to the Fed Target Rate. Remember that like you and I, banks borrow money too. But banks tend to borrow from each other from one day to the next instead of 15 or 30 years, and the interest rate they can charge each other for that borrowed cash is the same rate that the Fed is about to hike. Essentially what that means is that borrowing costs are going up for banks, and like any other business, banks will pass on those costs to their customers…you and I.

And that is the second issue. Do you owe a balance on your credit card? Are you about to buy or refinance a house by using a mortgage? Maybe you or your child is in college and you are utilizing student loans to pay some or all of the tuition? The interest rate on all these loans is about to go up. Like I said already, a quarter percent is no big deal, but in the context of rising 2.5% over the last two years, that’s a pretty big increase.

Which brings me to the third problem with this rate hike. If your interest rate on your mortgage was 3% when you took it out, say five years ago, and you borrowed $320,000, you would be paying about $1349 per month. If you were to take that same mortgage now, or if you would refinance your mortgage now, you’d end up paying $1767 per month, which is $417 more than the same mortgage five years ago.

That extra $417 comes to $5000 per year. I don’t know about you, but I think there’s a lot that I could do with that extra $5000 every year. Imagine if your boss came to you and said, “Sorry, we have to reduce your pay by $100 per week.” That would be the same as your monthly mortgage payment rising by $417.

And that is the fourth problem. Higher interest rates not only means that everything costs more when you buy it, but it also means you get to keep less cash in your pocket. So even if you take a vacation next week, your upgrade to first class is gone. Or maybe you have to buy smaller or fewer gifts this holiday season. Now don’t get me wrong, you’re still gonna buy food and clothes for your family. It’s all the little extras that you’re accustomed to that you’re giving up. And you know, just like you and I are making less purchases, businesses are doing the same as well.

The fifth problem, which is the biggest problem with a rate hike environment, is the same as the first. Remember I said banks borrow from each other but only from day to day? Well what do you think banks do with all the extra money they have? They don’t let it sit there collecting dust. They’d rather make loans. When the bank makes a loan, they want to make sure the loan will generate a profit. So if they borrow from each other at 2.5%, they’ll want to lend that back out to you and I at a much higher rate. But what happens if they can’t do that, and instead of borrowing low and lending high, the banks are only able to borrow high and lend low?

If you said the banks will lose money on that deal, you’re right. Banks don’t want to borrow at a higher rate than they lend out at. This is the biggest problem with this rate hike that will probably happen this week, and the reason is that banks lending money is to the economy what motor oil is to your car engine. If lending means losing for the banks, they won’t lend, because the banks aren’t in business to lose money. So if the Fed hikes on Wednesday, bank lending will come to a standstill, and if you take away that economic motor oil from the economy, you can bank on it that a recession is just around the corner.

Let me know in the comments if you’ve noticed your interest rates are going up or if you are starting to hear about foreclosures. Thanks for reading Volume 20 of The Macro Market Wrap Up With The Mad Genius. Until next time remember that there is always a bull market somewhere in the world, and on the opposite side of every crisis, lies opportunity.

#economy #Fed #interestrates #ratehikes #recession