The Fed cut rates ... now what? (featuring: Sasquatch)

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0:14This is The Indicator from Planet Money. I'm Waylon Wong. I'm Adrian Ma. And I'm Darian Woods. The indicator triumvirate has answered that clarion call because, as we heard from Fed Chair Jerome Powell this week, the committee decided to lower the target range for the federal funds rate by a half percentage point. 50 whole basis points. What does it all mean? We'll tell you all about it on today's Indicators of the Week. That's right. On today's episode, we've got dot plots. We've got why the economy might be squeezed even further, even though interest rates are lower. And we've got Sasquatch?

0:52An economic Sasquatch. From monetary policy to cryptozoology. After the break. A half percentage point. This message comes from Apple Card. Apple Card members can earn unlimited daily cash back on everyday purchases, wherever they shop. This means you could be earning daily cash on just about anything, like a slice of pizza or a latte from the corner coffee shop. Apply for Apple Card in the Wallet app to see your credit limit offer in minutes. Subject to credit approval, Apple Card issued by Goldman Sachs Bank USA, Salt Lake City Branch. Terms and more at AppleCard.com. Support for NPR and the following message come from Edward Jones.

1:34What does it mean to live a rich life? It means brave first leaps, tearful goodbyes, and everything in between. With over 100 years of experience navigating the ups and downs of the market and of life, your Edward Jones Financial Advisor will be there to help you move ahead with confidence. Because with all you've done to find your rich, they'll do all they can to help you keep enjoying it. Edward Jones, member SIPC. Indicators of the Week Fed Decision Day edition. So we are all aflutter over this week's half percentage point rate cut. My indicator is actually that same number again, because we might see another half percentage point drop by the end of this year.

2:21If that happens, rates could be just over 4 % by year end. And if you want more decibel places, that's around 4.375%. And this is according to something called the dot plot. I love that name, the dot plot. You actually did an episode about this a few months ago and basically explained like how this is a way for the Fed to visually represent where they think that interest rates are headed. That's right. The Fed released its updated summary of economic projections. The Fed puts out this report four times a year and the dot plot is part of it. And here is how the dot plot works. So if you picture the y-axis, that's the vertical one, you've got interest rates from 0 % to 7%.

3:01Then on the x-axis, which is the horizontal one, you have the years 2024 through 2027. Fed policymakers put a dot on the graph for where they think interest rates will be at the end of each year. Each dot represents an actual person at the Fed, by the way, although it's all anonymous. So this is like a nerdier version of pin the tail on the donkey. Yeah, I think Jerome Powell blindfolds them and spins them around and shoves them towards like a blown up version of the graph on the wall. So this includes members of the Federal Overmarket Committee, basically the folks who actually vote on interest rate decisions.

3:37And so you see the dot plot and it gives everybody in the world clues as to how these people might vote in the future. Exactly. And there's debate around how seriously people should take the dot plot because these are projections and not, you know, like promises of exactly what they'll do in the future and how they're going to vote. But Fed watchers really scrutinize the dot plot. Sometimes you see the dots moving around during the year, and that indicates that Fed policymakers are adjusting their thinking as they take in new data on things like inflation and jobs. OK, so we have two more Fed interest rate decisions before the end of the year.

4:11and I guess we'll see whether this dot plot prediction of another half percentage point cut happens or if the economy throws another curveball. I have a curveball for you. Oh no, we have one already? Yes. So my indicator is 6.15%. That's the interest rate you'd pay right now on a new 30-year mortgage. It's a decent drop from what it used to be. Okay, so this is what we would expect, right? When the Fed drops its interest rates, a little bit of a relief for people looking to borrow to buy a house. Yeah. And, you know, this week we've had a lot of fanfare about how dropping the interest rates this week will boost the economy.

4:49But, you know, because we at The Indicator are a little contrarian sometimes, there is actually an argument it may not really stimulate the economy very much. What are we even doing here? What are we even doing? I know. So I read this thought-provoking opinion piece in Bloomberg, And it said that the conventional logic of lower borrowing costs, simulating home purchases and household spending, may not quite apply this time around. Oh, but that's Monetary Policy 101. Yeah, exactly. So the standard way that you'd think about this on an economics class blackboard is that the lower interest rate would feed into more borrowing, more people would buy houses, more families have spare cash to spend on things that make the economy go round.

5:34But we are in a world where it's not as simple as this. I'm shaking my fist at the universe, Darian. But I'm also interested to hear more. Well, here we go. So this is all about the interest rates that people are actually paying at the moment. So not just the new mortgage interest rate. The U.S. is pretty unique. People can lock in those 30-year mortgages. So many people have those lower interest rates from years ago. They were shielded during those rate rises. Lucky break for them. Yeah, so the average interest rate that people in the U.S. are paying right now, according to Bloomberg, is just 3.9%.

6:12Some people are paying even less than that. So obviously, 3.9 % is lower than the 6.5 % that you'd have to get with a new mortgage right now, even with those lower interest rates. And so as more and more people move houses or move into the housing market, more and more people have to borrow at that higher 6.5 % interest rate. so they'll have less cash on hand to spend on things. Now, I want to be clear here that lowering interest rates is stimulatory, that this is just a potential headwind that the Fed might face among all the swirling factors of the economy. OK, but the Fed could lower interest rates even more, right?

6:52Yes, to really push down on that 3.9 % average, there'd have to be a really sizable drop in the Fed rates. And as we've heard from you, Weylin, given the pace of reductions, it's unlikely that we're going to see that by the end of the year. If you look at the dot plot, we might get there by the end of next year. Although, as we know, lots could still change in a whole year. Yes, it is not a promise. The question that I think this raises also is like, where are all these cuts leading to? Right. Is there a point where the Fed could say the interest rate where it is perfect? The economy isn't too hot.

7:27It's not too cold. a sort of Goldilocks Fed interest rate. Well, there's actually a term economists have for this called the neutral rate. Often it's referred to as the R star. And right now, analysts estimate R star to be around 0.9%. And when you add that to the Fed's target rate of inflation, which is 2%, what you get is a neutral interest rate of 2.9%. So that's my indicator of the week, 2.9%. And since the Fed's interest rate is above that equilibrium R-star rate at the moment, theoretically, that should be causing the economy to slow down. Exactly. And theoretically, if the Fed's rate were below R-star, that would cause the economy to speed up.

8:14Now, we should say here that the very concept of R-star is the subject of some almost religious debate in econ circles. Yes, this is making me think of Austin Goolsbee, who is the head of the Chicago Fed. He is an outspoken critic of Our Star. I don't like Our Star because I call it our Sasquatch. We can't see it. We don't know where it is. We can only tell what it was after it's passed. So how does Our Star affect our decision making? And you know, Goolsbee and other economists beef with Our Star is that it's like this almost mythical number That's very hard to calculate with precision and in real time.

8:55So it's not a useful guide for Fed policymaking. R-star haters argue that instead of shooting for some elusive, perfect interest rate, it's more important to look at what the data is telling you about the economy right now and then adjust accordingly. Listening to this actually makes this analogy sort of pop to my mind of running a marathon. Like when you're trying to win a marathon, do you focus on like hitting a specific pace? like a mile time that you think will help you finish but not burn out? Or do you focus more on the other runners and just sort of adjust to what is happening around you?

9:30That to me sort of encapsulates this like R-star schism. I'm an R-star Sasquatch believer. I'm out there in the mountains looking for it. R-sasquatch is out there. You're like Fox Mulder in X-Files. You want to believe. You want to believe. I mean, it's really a milestone that the Fed basically now thinks that that inflationary wave that we had during the pandemic is pretty much over. So are we calling it? We're calling it. They're calling it. You know, what if inflation may begin? Don't jinx us. Or at least it's the beginning of the end. They hope. They hope. Because there will be more rate cuts.

10:08Yes? That's what the dot plot says. I think our Sasquatch kid should get his own dot on the dot plot. Oh my gosh, it could be in the shape of a big paw. This episode was produced by Angel Carreras with engineering by Neil Rauch. It was fact-checked by Sierra Juarez. Kit Kinkannon edits the show and The Indicator is a production of NPR. A half percentage point. This message comes from Vanguard. Capturing value in the bond market is not easy. That's why Vanguard offers a suite of over 80 institutional quality bond funds, actively managed by a 200-person global team of sector specialists, analysts, and traders.

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