The chart below shows what the market expectations are for the federal funds rate over the next two years. The market is expecting that the Federal Reserve will not raise rates in June and will begin to cut rates later on this year.

 

 

Let's assume that the market has it right and the Federal Reserve will begin cutting rates in 2023. What typically happens when rates stay flat or start to go down?

1. Stock prices tend to go up: lower interest rates make it cheaper for companies to borrow money, which can stimulate investment and business activity which usually leads to higher earnings and increased stock prices.
2. Bond prices go up: as interest rates fall, yield on bonds fall as well. This makes bond prices go higher.
3. Currency goes down: typically lower interest rates lead to a weaker currency as investors seeking higher yields buy currencies of other countries.
4. Consumer spending increases: lower rates make it cheaper borrow money for mortgages, car loans and credit cards. This can stimulate consumer spending.
5. Inflation increases: once rates have been kept low enough for long enough the economy will start to run at full capacity which will lead to higher inflation and then, the cycle repeats its.

The playbook for rising and falling interest rates is not complicated. You may be wondering why I'm talking about interest rates going down now when it's unlikely that the Federal Reserve will start cutting until the end of the year. The main reason is that the market tends to be 6 to 9 months ahead of the economy. Which means if the Federal Reserve cuts interest rates at the end of 2023 we will begin to see the market reaction to expected cuts very soon.

 

We have also had a few questions on the debt ceiling crisis taking place in the United States. I will discuss this further in next week's note.

 

I've also included a piece from our CIBC Economics Team entitled “After you, Chairman Powell".

 

As always, if you have any questions please feel free to give us a call at any time.

 

Have a great weekend.

 

Milan