Pyrford Perspectives: the US Fed funds rate

Macro Update 12 July 2021
November 2019

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Risk disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

 

The US Federal Reserve recently lowered its benchmark funds rate to a range of 1.5% to 1.75%. Two members of the Committee voted against the reduction. The rate peaked in the latest cycle at 2.5% but steady quarter-point reductions commenced in July this year.

A brief history

Immediately prior to the “Great Recession” – the end of 2007 – the rate was 4.25% (having been 5.25% earlier in 2007). By the end of 2008 the rate was just 0.25% and there it stayed until the end of 2015. By the end of 2018 it had been nudged up to 2.5%. In other words, the Fed had the gap between 4.25% and 0.25% to play with in trying to bolster the economy during the financial crisis, but this time around its starting point is just 1.5%.

Risk disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Context is key

US unemployment currently stands at a rate of 3.5%. This is the lowest since 1969 and well below the long-term average of 5.9% (average since 1950). In other words, the employment situation is about as healthy as it gets. More context: the latest quarterly real GDP number has just been released, revealing growth at an annualised rate of 1.9%. This is slightly better than expectations. Should the Fed be disappointed with the growth rate? Hardly. Its own forecast suggests the long-term trend GDP path is now around 1.8%. The IMF expects 2.1% in 2020 and then gradually subsiding to 1.6% in 2024.

So, we just don’t get it. Why reduce rates to extraordinarily low levels when everything is chugging along OK? The gap between 1.5% and 0.25% or even zero is not very great, so the Fed has little firepower next time it really needs it – and yes, it is inevitable it will need it, as many of the issues surrounding the “Great Recession” remain unresolved. Of course, the same “lack of firepower” comment can be made of many other central banks – the European Central Bank and the Bank of Japan spring readily to mind.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

 

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