Latest / Real Investor Radio Podcast / Mini Episode #4 | Deciphering the Fed: Rate Cuts, Market Dynamics, and Banking Challenges
Transcript
- Craig Fuhr (00:12) Hey, it's Craig Fuhr with Dominion Financial. I'm a loan officer here and I'm with the co -owner of the company, Jack Bevere. Welcome to Real Investor Radio. We've got a quick hit for you right now sort of on the recent announcement from PAL and the FOMC. And Jack, for those who didn't tune into the last five to 10 minute episode that we did, we'll try to get it out to everyone, but I would encourage everybody to take a listen to that. But you teased sort of what you wanted to talk about on this quick episode in terms of what we might be seeing over the next 12 months from the FOMC and sort of what the other chairman of central banks around the country are sort of indicating what we could see in terms of rate cuts over the next 12 months. So why you jump in there. Jack BeVier (00:58) Yeah, so everyone's really focused on the Fed having just on a 50 basis point decrease in the overnight rate, which they should be. It's a big move. It was a bigger move than the market expected. What I think is even more interesting is what the Fed is projecting the overnight rate is going to be for the next 12 months. So zoom out a little bit, bear in mind and bear in mind that the Fed is the overnight rate is what the banks, what America's banks regulated banks can borrow money from the Federal Reserve on an overnight basis. So the idea that a decreasing Fed funds rate, what that does is decrease bank cost of capital. They can borrow more cheaply. Craig Fuhr (01:43) And that's sort of short term capital, right Jack? Like short term loans? Jack BeVier (01:47) Exactly, exactly. And that overnight rate is very, very closely tied to other short -term indices like the secured overnight funding rate, SOFR, which was the replacement for LIBOR. LIBOR used to be used, it got phased out in favor of SOFR. But when the Fed funds rate dropped 50 basis points last week, SOFR dropped 50 basis points last week. so... The fed governors, when you, the, they project out what they publish, what they think they each, you know, it's a survey basically, of what each of the fed governors thinks that the fed funds rate is going to be over the course of the next year. And that's called the dot plot, just because the way that they present the information, there's a bunch of dots on it. And so what that dot plot says right now, everyone's focused on the 50 basis point drop, but what the dot plot says right now is that the. terminal rate for this decrease for this for this interest rate cycle is about 200 basis points lower than where we are today an additional 200 basis points of drop in the Fed funds rate over the course of a 12 month period so that sounds like if you're a bank you know on your space you're like great so it's going to be cheaper for banks to lend not so not so quick We're like not so fast. Craig Fuhr (03:16) Signal versus noise jack. Jack BeVier (03:18) Yeah. The, so on its face, that sounds like, that's going to be good. That'll be stimulate, you know, that'll, that'll stimulate the economy because bank bank loans are going to get cheaper. I'm concerned about that. I don't think that that's necessarily the case because of what else is going on structurally in the banking system right now. So when, you know, the banks have a lot of loans, you know, lines of credit to companies and unsecured, lines that, you know, like, the, exactly. Yeah. That are tied to sofa. Craig Fuhr (03:42) receivable loans, things like that. Jack BeVier (03:47) So as the fed continues to drop the rates, new originations can get cheaper. You would think they might be able to get cheaper. I'm going to challenge that idea in a second. but the, but the existing book, the rates come down. So it's really good for businesses, right? Businesses who have lines of credit, their cost of capital is going to come down because the banks are going to drop because a sofa comes down that the interest costs is going to come down. the interest charges are going to come down on those lines of credit. So it's great for businesses, not so good for banks though, because they're going to get squeezed, right? Like they were charging us 8%. And now they're going to be charging us now that today they're charging us seven and a half next month, it'll be seven and a quarter. so exactly the problem though, if you're a bank is, and so your margin is going to get squeezed if you're a bank because Craig Fuhr (04:33) And in 12 months, it could be like five and a half. Jack BeVier (04:44) You know what hasn't come down? Deposits. And that's a big chunk of bank liabilities. So we've all got it. You we all got used to, you know, we took us, you know, as consumers in America and businesses in America took us a couple of months to figure out that, crap, we really need to be moving our, cash that was used to be sitting on the sidelines and as interest, non non -interest bearing checking account into a money market or short -term CDs, because now we're getting four and a half, five and a half percent on that money. Craig Fuhr (04:46) deposits. Jack BeVier (05:14) Now banks are going to really want to push that down because they've got an alternative one because they're getting pressure within their book that their loans are the rates that they're collecting from borrowers are coming down. And so they're going to want to put, and they've got an alternative source of borrowing from the overnight window from the fed. so banks are going to want to start pushing down those CD rates, pushing down those savings account rates. over the course of the next 12 months, I think we're going to see a big, all of a sudden we're going to see erosion of the CD rates and of the savings account rates that we're currently getting, in the, from, from the banks, because their margins are getting squeezed and they can't have, you know, they can't have, loans on their books at five and a half percent because, you know, the rates of, cause so first come down 200 additional basis points and they're still paying. you know, Sally American, you five, that's, that, that business is not going to work for them. so I think that that's a trend that we're going to see over the course of the next 12 months that no one, think I haven't seen anyone yet talking about that, but I can't imagine how the banking system would continue to function if they don't start cramming us American consumers down on the, the deposit rates. Craig Fuhr (06:34) And so, you know, I guess to tie it all up with a bow, great for the consumer in that, you know, they're borrowing now at a significantly less, you know, at significantly less interest, but a lot of strain on an already strained banking system, especially many of the regional banks around the country that do this kind of business. Jack BeVier (06:56) Well, I think maybe good for some consumers. I'm going to put a little asterisk in that statement. think you're generally right, but I think it's going to be good for some consumers, those consumers who are working with banks that have a low cost deposit base. you know, if you're, if you're not getting any, if you're, you're getting very little, if you're, if your bank is still only paying 2 % on deposits, then those folks aren't going to have this same margin compression pressure. And so they may be able to originate at lower spreads, but you may actually see an increase in credit spreads. If you're, if you're at a bank that has, you know, increased a lot of money, sorry, increased deposits by paying for them, right. Paying up for those deposits. I think you may see quotes that stay at the, at the higher rates for longer because, you know, consumers just don't accept it right away. Right. The, know, you, you, drop deposit rates. It's so easy now to move your money between banks. you can, you know, you go to a company, you go to a website like raisin and you can see, you know, 30 different bids for your deposit rates. And so you just sort by whoever's paying you the most it's insured by the federal government, it is and move your money from one bank to the other. So banks are going to want to push deposit rates down, but as soon as they start doing that, the first mover is going to see flight. to other banks. so the regulators are still, you know, the banks are under still under super watchful eye of the regulators. So the first bank that tries to decrease deposit rates in order to maintain margin is going to have a flight of deposits to other banks. And then that bank will have the FDIC up their ass because they're because their loan to deposit ratio is all of sudden out of whack. So it's going to be a tough, I think it's going to be tough balancing act, a tough balancing act for banks to pull off. over the course of the next 12 months. since the Fed is telling us that they are going to drop rates almost as fast as they raised them, there are going that is going to lead to some mess, right? Like you can't move interest rates that quickly and not have some unintended consequences. And I think that's the category that that's the that's the area that we should be paying attention to in this rate decrease cycle. And there'll be, you know, I would expect there to be some shakeup as a result of that. Craig Fuhr (09:23) Jack, I pulled up a great quote from Thomas Jefferson, you know, the prescient quote from 1816, and where he was talking about the role of central banks. And he said, if the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property. think that's a very interesting quote during this time. Jack BeVier (09:56) And a lovely closing quote for this segment. Craig Fuhr (09:59) Yes. All right. That's a quick one from Real Investor Radio. I'm Craig Fuhr with Jack Bevere. Thanks for tuning in.