Fed Keeps Interest Rates High; Jobs Grow for 40th Consecutive Month

0:00The big economic news this week is that interest rates are staying high. Interest rates which are at a 23-year high are going to remain that way for quite some time. The Federal Reserve Board of Governors met just a couple of days ago, and on Wednesday at 2 p.m. Eastern made the announcement that they are holding interest rates steady. Now, the Fed meets eight times per year. That's on average once every six and a half weeks. But they are widely expected to hold rates steady at their next several meetings. In fact, there is speculation that interest rates may not decline until late in the year.

0:39How far in advance can we reasonably make these predictions? And what does this mean for your wallet, for your mortgage, for your car loan, for your credit cards, for your finances, and for the businesses that you run or the jobs that you apply to? What does this mean for you? We're going to tackle that in today's First Friday bonus episode. Welcome to the Afford Anything Podcast. You can afford anything, but not everything. Every choice carries a trade-off, and this is a show about optimizing your limited resources, including money, time, focus, and attention. I'm your host, Paula Pant. I trained in economic reporting at Columbia, and I help you cut the noise and focus on what matters so you can lead a wealthy life.

1:23On the first Friday of every month, we broadcast a monthly economic update. So welcome to the May 2024 First Friday Economic Update. The big news right now is that statements made by Fed Chair Jerome Powell, particularly his most recent statement, which he made on Wednesday, has led many analysts and investors to pare back their expectations of how soon interest rate cuts will begin and how many interest rate cuts we are going to see this year. Previously, towards the beginning of this year, many analysts thought that we would start to see interest rates come down this summer. There was even a debate, is it going to be Q2 or Q3?

2:10That was what people were arguing. but inflation has not come down as much as people had hoped, nor is it coming down at the rate at which people hope. So the Fed's target rate for inflation is 2%. We're not there. Everybody knows that we're not there. That's not news. What is notable is that the rate of decline has slowed, meaning inflation isn't coming down towards 2 % as fast as analysts had previously hoped. On top of that, hiring is still strong. Unemployment is at a near 70-year low. Consumer spending is strong. And so it looks like rates are going to stay high for a while. The goal of high interest rates, of course, is to slow down the economy.

3:03And that happens because when capital becomes more expensive to access, both producers and consumers borrow less. Producers borrow less money to reinvest back into their businesses and consumers borrow less money to spend on goods and services. And so in both directions, economic activity slows down. But what we've been seeing so far in 2024 is that despite the high interest rates, we have such a strong economy with such high levels of employment and lots of cash on household balance sheets that accumulated during the pandemic. That cash, of course, is declining, but it's still in play. And certainly it has been for the first half of this year.

3:55And as a result of all of that, the slowdown in economic activity that people were expecting to see as a result of the rate hikes is taking some time to move through the economy. So quoting directly from a statement that was released by the Federal Reserve on Wednesday, the statement says, quote, quote, in recent months, there has been a lack of further progress toward the committee's 2 % inflation objective. So those are the keywords, a lack of further progress. And the statement reiterated the Fed's goal of returning inflation to its 2 % objective. That's a direct quote. So the federal funds rate will remain at between 5.25 % to 5.5%.

4:44That is the rate at which commercial banks borrow and lend their extra reserves to one another overnight. What does that mean? How it works is you deposit your money at a bank and your bank deposits are what provide that bank with the money that they need to be able to give out loans. But the bank is also required to be able to keep a certain percentage of their total capital in reserve. Basically, they have to have cash reserves in the same way that it's a good idea for you and me to have an emergency fund, they also have to have, in essence, an emergency fund. They have to have their own cash reserves.

5:25But the amount of cash that they have fluctuates day by day as deposits come in and go out and as loans are approved and repaid, right? So the amount of money that they have is really volatile. And so what that means is that sometimes in order to meet those reserve requirements, banks have to borrow money from other banks, but just overnight. It's not a long-term loan, it's just an overnight loan. The rate at which banks borrow that money overnight, that's the federal funds rate. And so when I say that it's between 5.25 % to 5.5%, that's the upper and lower bound. It's going to fluctuate in between those two upper and lower bounds.

6:08Now, because banks are borrowing money at 5.5%, when they lend money, they need to have some kind of a spread. And so right now, as of May 1st, the national average for a 30-year fixed rate mortgage is 7.75%. That's according to USA Today Blueprint. Interestingly, the gap between jumbo loans versus ordinary non-jumbo loans, that gap has closed. Typically, there's some distance, some decent distance between the two numbers. That was certainly the case in 2022 and 2023. But right now, a 30-year fixed rate mortgage is 7.75%. A 30-year jumbo is 7.72%. So that's at least a smidge of good news for those of you who live in very high cost of living areas.

7:04But all that said, returning to the main point, there does not seem to be any interest rate relief on the horizon. Your mortgage rate, your car loan, these are likely to be high for even longer than we expected. The good news is that the prediction that was made two months ago by former Treasury Secretary Larry Summers does not seem to be coming true. Now, former Treasury Secretary Larry Summers, who is a renowned economist, he's also also the former director of the National Economic Council and the former president of Harvard. Two months ago, he went on Bloomberg television and stated that there is a meaningful chance that the Fed might hike rates.

7:51In other words, he thinks that there's still room for interest rates to climb. Now, to be fair, he did not predict that that would happen. He simply stated that it is not outside of the realm of possibility, but he did float that as one of many possible outcomes. Around the same time that he made those remarks, he also indicated that he believed that there was about a 15 % chance that the Fed would not lower rates at all this year. And so that 15 % chance, of course, could encompass the Fed either hiking rates or keeping rates steady. So even if we were to accept the premise that there is a 15 % probability that rates either rise or stay steady for the remainder of the year, that still, even in his estimation, gives us an 85 % probability that rates would come down at some point this year.

8:53Although by now, it's pretty widely agreed upon that it's likely to be later in the year than people had previously expected. And there are likely to be fewer rate cuts this year than people had expected. Now, we've talked about what this means for mortgage interest rates, but what does this mean for home prices? Well, according to a report released by Redfin on Thursday, home prices are up 5 % year over year in almost every major U.S. city. So what we see is that in spite of the fact that mortgage interest rates are closing in on 8%, about 7.75 % home prices are still rising and they're up 5 % year over year.

9:41Now, why is that? in one word, supply. Not enough new homes are being constructed and homeowners who have existing fixed rate mortgages that are under 5 % have a golden handcuff scenario. This is referred to as the lock-in effect, but it's essentially the golden handcuffs of mortgage interest rates. Existing homeowners are disincentivized from selling, which means there is even less supply coming onto the market, which further pushes up home prices. Now, this makes it incredibly challenging for first-time homebuyers to enter into the housing market. And that is something that the current Treasury Secretary, Janet Yellen, said during testimony before the House Ways and Means Committee on Tuesday.

10:31First-time homebuyers are facing three challenges, low inventory, high mortgage rates, and high house prices. There are fewer homes available, they're expensive, and you have to pay even more money to borrow to get them. For those of you who are currently struggling with this problem, if I may, and this is Paula editorializing right now, house hacking. Get a duplex, a triplex, a fourplex, or a single family home that has a guest house, an in-law suite, a separate autonomous basement unit. I could easily do an entire episode on house hacking, but that would be a different episode for a different day.

11:09So I'll just leave this as a very quick tip right now. And if you do want to learn more, go to affordanything.com slash VIP list. It's no cost to you. Just sign up at affordanything.com slash VIP list. Shoot me an email, ask me any question that you have. If you are a subscriber to the VIP list, I am answering your questions. If you email me a question, I will answer it on a live stream on YouTube. I've done two live streams this week already, and I'll be doing a couple more this weekend. So affordanything.com slash VIP list, no cost, subscribe there. Once you've subscribed and you get a VIP list email, just hit reply, send me your question, and I'll answer it on YouTube.

11:56But for this episode, let's continue to focus on the data because while the stats that I just gave you are about home prices nationwide, it's important to remember that every market is local. And there are specific local markets, particularly in the South and in the West, where prices are starting to slip a little bit. So in Dallas, in Phoenix, in Miami, in those areas, in the short term, the housing market has seen a very slight decline. In the month of March, that was a decline of less than one half of 1%. It was 0.4 % in Miami and Phoenix and 0.3 % in Dallas. Negative. So there is a bit of a softening of home prices in the West and in the South, but that may be because those areas also saw some of the biggest increases over the last couple of years.

12:48There's also the added concern that in some of the Gulf Coast areas, rising insurance rates is starting to weigh on homeowners. And so in Florida in particular, there is some additional inventory that's coming onto the market. Certainly in the Tampa St. Pete Clearwater area, which is the area that I've looked most closely at in Florida, it's not right now a good time to sell in my own personal estimation. Now, I talked a bit about the golden handcuffs, the lock-in effect. I have a hypothesis that that feeling of a lack of mobility is contributing to the negative economic sentiment that a lot of people are feeling.

13:34So in a recent Gallup poll, only 24 % of adults in the US described current economic conditions as either good or excellent. The other three quarters of the population described it as fair or poor. So 32 % described it as fair, 44 % described economic conditions as poor. I've talked before on some of these First Friday episodes about the delta between popular sentiment and economic data because we have record low unemployment. We are at a 70-year low in unemployment. It has never been easier to get a job or to switch jobs, at least speaking in the aggregate. Obviously, there are disparities inside of industries and inside of specific geographic locations.

14:31But in aggregate, this is the golden era of employment. And on top of that, the bull market is raging, which the majority of Americans, nearly six out of 10 Americans participate in the stock market, typically through a 401k or a 403b or some other type of retirement plan. So we are at nationally all-time highs of the percentage of Americans who participate in the stock market and who own stocks. Meanwhile, the stock market itself just keeps climbing. All of the major indices are doing well. And yet when people are polled about how they feel about the economy, the sentiment is largely pessimistic.

15:18And the best, I mean, I know I just cited a Gallup poll, but the best resource for this, in my estimation, is the University of Michigan, which puts together a consumer sentiment index. Since January, consumer sentiment has stayed very, very stable. It stayed within a 2.5 index point range, which means that any variation in measured sentiment is not statistically significant, which is just a very long and complicated way of saying consumer sentiment is stable. It is unchanging. It has plateaued. And it is low. Consumer sentiment is remarkably and significantly much, much lower than it was in 2016, 2017, 2017, 2018, 2019.

16:06Of course, it was lower in 2020, but actually not by much. I'll put a link in the show notes where you can see the charts. And so what's interesting to me is that even as markets have risen, even as inflation has abated, consumer sentiment has remained constant and constantly low. And I believe that there are a variety of factors. Of course, the most common explanation is everything's more expensive and people feel the pinch. True, but wages have also grown. unemployment has shrunk. Portfolio balances are higher. For people who do own homes, home equity is higher. But for people who own homes, mobility is lower due to the golden handcuffs lock-in effect.

16:48So if you own a home, your mobility is reduced. And if you don't own a home, it's really hard for you to buy a home. So you have a situation right now where both homeowners and renters feel stuck. Homeowners feel stuck because they have golden handcuffs. Renters feel stuck because of the trifecta of low inventory, high housing prices, high mortgage rates. So both groups feel stuck. One suffering from scarcity and the other suffering from abundance. I mean, the golden handcuffs problem is a problem of abundance. So it's the opposite problem, but it's the same. It's the same. It's that feeling of stuckness.

17:33It's that feeling of lack of mobility. And my hypothesis is that that has an effect on this low consumer sentiment that we are seeing, this pervasively low sentiment. And unfortunately, there are only two things that can be done about it. Inflation needs to come down and housing supply needs to increase, both supply and density. That's a big part of why I, again, going back to house hacking, a big part of why I encourage my students in my course to retrofit their single family home into a two unit, right? section off the basement or section off the garage and renovate it and turn it into an autonomous unit with its own ingress and egress.

18:23Because by virtue of doing so, you are, number one, contributing to the solution at a societal level. And number two, making money that's going to offset your own expenses. So that's a bit more of my editorializing, but house hacking I see as the solution for a lot of the issues that we are facing right now. And it's one of the elements that I don't hear coming up in mainstream discussion, which is why it's important to me to emphasize this on this platform. Oh, by the way, I know I've kind of casually mentioned that we're living in a golden age of employment. What I have not mentioned is the April jobs report.

19:08Today, the first Friday of the month, Friday, May 3rd, the April jobs report came out. This report, which is published by the Bureau of Labor Statistics, was not as good as people had expected. It's a bit of a mixed bag. You see, yesterday, Thursday, May 2nd, analysts were expecting that April's job report would reflect 241 ,000 new jobs. Now that's non-farm payroll jobs. That was the expectation. That was the scuttlebutt, if you will. And by the way, if you want to independently verify that, just look at the articles that were published yesterday. Look at the articles that were published on Thursday, May 2nd, as experts predicted what the jobs report would say.

19:53Compare that to the actual report that came out today, Friday, May 3rd, and you'll see the disparity. On Thursday, people were expecting that the jobs report would reflect 241 ,000 new jobs. Today, the actual report came out and it reflected 175 ,000 new jobs, meaning the expectations were a little overly optimistic. Let's put this in context. The April jobs report is the 40th consecutive month of job growth. It is also the 27th consecutive month in which unemployment has remained below 4%. So historically speaking, it's quite strong. But what is significant about the expectation of 241 ,000 versus the reality of 175 ,000 is that that differential means that unemployment ticked up by 0.1 percentage points.

20:51Unemployment ticked up from 3.8 % to 3.9%. Essentially, the expectation was that unemployment would remain steady at 3.8 % as it has for the past several months. The reality is that it ticked up to 3.9%. What that signals is that the job market is cooling just slightly. It is still robust, but it is also cooling slightly, which is what the Fed wants. The Fed wants to cool the economy to bring inflation down to 2%. So the fact that new jobs are being added, but they are being added more slowly than expected, may be a sign that the economy is finally starting to see the effects of the higher interest rates and is finally starting to cool slightly because there has been a bit of a lag time between when interest rates rose and any type of cooling effect.

21:46The economy has remained surprisingly robust despite these high interest rates. And we're living in, if we zoom out, a very unusual situation because we had a zero interest rate policy era called the ZERP era, zero interest rate policy. And that era gave way to a period of dramatic inflation that led to a dramatic interest rate increase that happened quite suddenly. And that juxtaposition has created this incredibly strange set of economic circumstances. The fact that we are currently living in an era in which the APY on your savings account could be higher than your mortgage interest rate if you got a mortgage two years ago or three years ago, right?

22:35The fact that you could arbitrage between your mortgage and a savings account, that is incredibly unusual. And that is the result of going from the ZERP era straight into the current interest rate environment. So we're living in this weird time where for millions of people, it makes more sense to hang on to your mortgage and keep the money in a savings account. That's weird, but that's the reality right now. We're also living in this weird time in which interest rates are high, the cost of accessing capital is high, and yet the economy remains robust. That's not supposed to happen, and yet it is.

23:18And so the fact that the number of new jobs added in April fell short of expectations, the fact that unemployment ticked up by 0.1 percentage points is an indicator that maybe the cooling is starting just slightly. But we have a long way to go before inflation comes down to 2%. A long way, unfortunately. In March, the CPI rose by another four-tenths of a percent, seasonally adjusted, and prices rose 3.5 % over the last 12 months. Now wages, average hourly earnings rose 4.1 % over the last 12 months. That's as of March. And that can sometimes lead to what economists refer to as a wage price spiral, where wages and prices both rise in tandem because each one has to support one another.

24:10Employers have to raise their prices in order to pay workers higher wages. Workers need higher wages in order to afford the higher prices. And so the wage price spiral means that everything just rises in tandem. And so the economy is going to need to cool down a little bit in order to pull us out of that spiral. It has been, even in spite of the high interest rates, incredibly resilient for a long time. And so the April jobs report indicates that we might just be beginning to see some of that cooling. Now, these First Friday episodes are dedicated to bringing you news about the economy and how it affects you and bringing you that information at no cost to you.

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28:37Welcome back. Let's talk about the stock market. And let's begin by zooming out big picture and taking a look at what happened last year in 2023. Because as we know, the S &P 500 rose 24 % last year. Massive, massive stock gains. But what we can easily forget is that last year, there was a regional bank meltdown. Remember Silicon Valley Bank, Signature Bank, First Republic? Remember a year ago at this time when people were genuinely nervous about whether or not the FDIC would insure their deposits, right? There was a bank meltdown a year ago at this time. We were living in a high interest rate environment.

29:20People were worried that we were going to go into a recession. And a lot of the chatter at the time was around, how do I flee into safety? Just think back to this time a year ago. I think one of the most enlightening things that a person can do in order to understand the economy and to understand the markets and in turn investing is to look back on what the headlines were in the past. I alluded to this earlier when I said, you know what, compare the jobs report data today. Compare today's news to yesterday's news, right? Compare the actual jobs report, which came out today. Compare that to the expectations, which came out yesterday.