How Your Interest Rates will Rise when the Fed Cuts

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Episode Transcript

Speaker 1 (00:00):
Do you think interest rates will be going up or
be going down in twenty twenty four. Well, billionaire investor
Bill Ackman expects the Fed will cut rates rapidly this year.
According to Forbes, the Fed will be slow to cut
interest rates this year. According to Bloomberg, the Federal Reserve
will lead the charge in cutting rates, with the rest
of the world following suit. Recent report from The Motley

(00:22):
Fool also agrees the Federal Reserve will be cutting rates
in twenty twenty four, while others are focusing on hints.
The Federal Reserve gave at its last meeting about three
potential rate cuts in twenty twenty four. Meanwhile, morning Star
predicts six interest rates cuts this year, and all across
the board, all we see is headlines of rate cuts
and more rate cuts. It seems like, according to most expectations,

(00:45):
the only question is how much will the Federal Reserve
cut rates by and how often? But what if I
were to tell you that this year the Federal Reserve
will cut interest rates, but the result of that will
be that interest rates will actually go higher. And what
if I were to tell you that not only is

(01:05):
this possible, but it has happened before and it happened
during the exact same situation we are facing today. First,
we have to take a look at the federal funds rate.
This is a chart of the federal funds rate, which,
as you can see, has been on the decline since
about nineteen eighty and most people are not aware of this.

(01:26):
But the federal funds rate is the only interest rate
that the Federal Reserve actually controls. So what is the
federal funds rate? The federal funds rate is the interest
rate at which depository institutions trade Federal funds with each
other overnight. When one depository institution has a surplus of
balances in its reserve account, it lends to other banks

(01:50):
that are in need of larger balances. In other words,
a bank with excess cash will lend to another bank
that needs that cash. The Federal Resons sets a tight
range at which this lending and borrowing of overnight cash
needs can happen. If the market rate starts to get
too high because too many banks need cash, the Federal

(02:12):
Reserve itself will enter the market and intervene by injecting
the cash necessary to cap the rates. If the rate
starts going too low, because nobody needs cash, and everybody
maybe needs the collateral. They will intervene yet again to
make sure the interest rate doesn't drop too low. What
you are left with is the effective Federal funds rate,

(02:32):
which is going to land somewhere in between their tight range.
And like I said before, this is the only interest
rate the Federal Reserve actually controls, and it is at
the shortest end of the yield curve. It is an
overnight interest rate. This is very different than the interest
rate on all of the forms of debt that individuals
and also most institutions actually care about. This is different

(02:53):
than the interest rate on US government debt treasuries, This
is different than the interest rate on mortgages, on audit loans,
on credit cards. It can and does have an influence
on those interest rates, but the Federal Reserve does not
outright control any of those interest rates, only the federal
funds rate. So who sets the interest rates on all

(03:13):
the forms of debt that people like you and I
actually care about. Well, it's actually primarily driven by free
market mechanics. Not entirely free. There's certainly a lot of
influence and a lot of corruption and a lot of manipulation,
But one of the primary driving forces is actually free
market mechanics, at least for now. You see, if I'm
the bank and you want to buy a car, so

(03:35):
you need to borrow thirty thousand dollars from me, and
you're going to pay me back over the course of
the next five years, I'm going to take a look
at what I think will give me a real return
on that money. Because if I just keep the cash
and I think inflation is going to run at three
percent over the next five years, then I'm losing three
percent on that cash every single year by not doing

(03:57):
anything with it. But if I give it to you
and give you a loan for let's say five percent,
now I'm gonna net the difference between the inflation rate
and the interest rate I'm giving to you, which is
going to be a two percent positive return in real terms. Now,
for everybody out there thinking about fractional reserve banking and
that they don't actually care about a real return because

(04:17):
they're getting some of a return on non existent money,
you're right. We're going to come back to that in
a moment. Now, for everybody thinking, hold up, they don't
actually have that cash, and so they don't actually care
about a real return on that money because they're not
holding it every dollar day loan. They're just lending into existence.
So they're okay taking an interest rate that's blow the
inflation rate. You're right about that, But let's explain what

(04:38):
that means when they're loaning money into existence. If you've
never heard of the concept of money being lent into
existence before the source or the origin of new dollars,
it can be a little bit difficult to grasp. When
I was in college, I was actually terrible with money.
Number One, I had a full ride scholarship. Number two,
I worked all through college. And number three, I graduated

(05:00):
with zero dollars in my bank account and thirty thousand
dollars debt because every single year I took out the
max amount I could in student loans even though I
didn't need it, and I spent it all at Chick
fil A and the gas station on energy drinks and
donuts and chips. Yes, I was extremely dumb, and yes
I got very fat in college, but that's not the

(05:22):
point of the story. The point of the story is
that a lot of the money I spent in college
came from student loans. For me to get that cash.
An arrangement was made between myself and the lender and
my university, and they credited or sent dollars over to
my bank account that didn't exist before. When that loan
was made, a deposit was made into my account, but

(05:45):
it was not transferred to my account from a previously
existing source. That loan was dollars being lent into existence.
And this is something that banks are allowed to do
in the United States because of how fractional reserve banking works.
When you make a loan, you're not transferring money from
your own account at the bank to somebody else's account.

(06:05):
You are lending those dollars into existence. I got those
dollars in my bank account, and I spent them on
junk food. I spent it on gas, I spent it
on energy drinks, and every time I made a purchase.
Those dollars were then transferred out into other accounts and
to my room and board payments, to the gas station,
to the fast foods bank account. So as a result

(06:25):
of that loan, there were now new dollars in circulation
in the economy. But it's not all fun and games.
Remember this is debt. It has to be paid back
and I had to go through a lot of struggle,
tons of hard work, and a really great system in
order to get out of debt, which my wife and
I were able to do within one year of graduating.
Is actually one of the things that I teach members
of Harecy Financial University how to do, so that you

(06:48):
can stop paying interest on massive amounts of debt as
quickly as possible and start actually getting ahead on your
financial journey, investing and making money for yourself instead of
flushing money down the toilet. But if you've ever paid
off debt before, one thing you'll notice is you're taking
dollars that were in circulation because you get them through
a paycheck or through a sale or some money that
you earn, and you use that to pay off a loan. Well,

(07:10):
guess what. That loan then just ceases to exist. It
gets paid off, it goes away. That money doesn't sit
in the lender's own bank account. That loan was an
asset to the bank, and now that that loan is
paid off, the asset disappears. It's gone, and those dollars
that were floating around in circulation are no longer in
circulation because you got them as income and use them
to pay off debt. So just as money is loaned

(07:31):
into existence, when debt is paid down, those dollars cease
to exist. Okay, it might seem like we bounced around
a ton. Number One, we talked about the Federal Reserve
is going to lower interest rates, but that's going to
cause interest rates to go up. Number two, we talked
about what the Federal funds rate is, and how the
Federal funds rate is the lending rate between banks overnight
and it does not directly control any other interest rates

(07:53):
that is set by market forces. Those market forces and
expectations about inflation are what push up and down on
interest rates for things that you and I care about.
And not only that, that debt that we borrow and
lend and payoff causes the money supply to expand and contract.
So let's put this all together now to us understand

(08:13):
how this is going to cause interest rates to go
up even if the Fed tries to cut that. When
the money supply expands and contracts, it's fairly commonly understood
by at least viewers of this channel now that that
has an impact on prices. All else being equal, if
you increase the money supply, a lot that's going to

(08:33):
push prices up. All else being equal, if you decrease
the money supply a lot, that's going to push prices down.
Going back to the federal funds rate, we can see
that ever since the eighties, it's been trending down. This
is the overnight rate, which has most influence on short
term debt. This is a chart of the one year
government bond, and you can see the interest strate on

(08:53):
this looks very similar to the federal funds rate. Ever
since nineteen eighty it's been trending lower, which means that
when the federal funds rate goes down, the US government
is able to directly borrow at lower rates as long
as they're borrowing for a very short term time period.
This is done through a specific type of US government
treasury bond called a Treasury bill. As of January of

(09:17):
twenty twenty four, the interest rates are in between five
and five and a half percent on these tea bills.
If the federal funds rate goes down to let's say
three percent, then the t bill rates will likely be
a lot closer to three percent than the five percent
that they're at right now. The US government already likes
borrowing at the very very short end of the curve.

(09:39):
They love using tea bills to make up a lot
of their borrowing, and if that borrowing becomes even cheaper,
they're going to like that even more. Right now, the
interest on the national debt is a huge concern because
it's becoming such a large line item on the overall budget.
They're spending over a trillion dollars a year just on
the interest on the NASH debt, which means if they

(10:02):
are able to borrow at lower rates, this helps with
that and increases their ability to spend and borrow without
having to worry about the consequences until later. Are you
seeing how this starts to play out now? Step number one,
The Federal Reserve cuts interest rates on the federal funds
rate that is the shortest end of the curve, the
overnight rate. As a result, it also pushes down interest

(10:25):
rates at the short end of the curve, like these
T bill rates. This gives the US government the ability
to borrow much more and spend more freely. We know
that when debt is created, when money is borrowed, that
is dollars being loaned into existence. So as a result
of the federal funds rate going down, the government borrows
more and spends more. That increases the money supply. And

(10:46):
what happens when the money supply increases inflation prices go up.
And if inflation starts to increase again, do you think
your lender is going to give you a three percent
mortgage or do you think it's more likely mortgage rates
stay at six or seven percent If inflation starts to
pick up again, do you think you're going to get
an auto loan for three or four percent or do

(11:07):
you think it's likely they stay around nine or ten percent.
Do you think your credit card rate is going to
go back down to fourteen percent or do you think
it's going to stay up at twenty five percent? If
inflation starts to pick up again, it is more likely
than not that all of the interest rates for the
type of debt that individuals and institutions care about go up.
The only person experiencing cheaper borrowing will be the US government.

(11:29):
Uncle Sam, and like I promised in the beginning of
this video, we are going to look at a time
that this has actually happened before. Because we understand the mechanics,
it's possible the Fed lowers borrowing rates for the government,
so they borrow more, they spend more. That cause inflation
to go up, so borrowing rates for everybody else actually
go up. This is a chart with a ton of

(11:49):
lines on it, so please bear with me. I'll explain
what you're looking at here. The blue chart line is
the Federal funds rate. If you look at the dates
at the very bottom, this goes from nineteen sixty seven
through nineteen eighty two. This was the very last time
we had a long term cycle of prices and interest
rates going up. I've talked about this long term cycle

(12:09):
before that lasted about forty years, peaked in nineteen eighty.
The next forty years was from nineteen eighty to twenty twenty,
and that was inflation and interest rates dropping. I believe
we've entered into the next phase of this long term
debt cycle that will be similar to nineteen forty through
nineteen eighty, with inflation and interest rates both going up again.
But right now we're just focusing on nineteen sixty seven

(12:31):
through nineteen eighty two. The blue chart line is the
Federal funds rate. This is the interest rate that the
Federal Reserve directly controls The orange chart line that you're
seeing here overlaid is the interest rate on the United
States ten year treasury. So when the government borrows a
ten year loan, meaning they have to pay that loan
back in ten years, that's called a ten year treasury
and this orange line shows the interest rate that the

(12:53):
government was paying on those new ten year bonds during
that same time period. The first time period I would
like to look at is August of nineteen sixty nine
through September of nineteen seventy During this period of time,
you'll see the blue chart line, which is the federal
funds rate, dropped significantly, while at the same time, the
orange line, the interest rate on the ten year actually

(13:16):
went up. We can also see from September of nineteen
seventy three through February of nineteen seventy four, the blue line,
which is the federal funds rate, which the Fed actually controls, dropped.
They dropped interest rates, yet at the same time the
ten year actually increased in its interest rate. And for
the last period of time here we have July of
nineteen seventy four through May of nineteen seventy five. Again,

(13:40):
the Federal Reserve drastically cut rates as shown by the
blue line going down. That's a federal funds rate, while
the orange line, which is the interest rate on the
tenure treasury again actually rose. Historically, the ten year is
much more closely tied to things like mortgages and car loans,
the things that people care about than the federal funds
rate actually is. This was three periods of time during

(14:03):
the early nineteen seventies where the Fed cut interest rates
and the result was a reigniting of inflation that caused
interest rates like the ten uere to actually go up.
We are in a time period right now that is
very similar to the seventies where everybody thinks inflation is dying,
inflation is done. We had a little burst of inflation
from the money printing that happened in twenty twenty and

(14:24):
that's all over now, just like they thought during the seventies,
which caused them to cut rates that reignited inflation and
result in them having to raise rates much higher later
on very similar time period to what we're facing today.
Long term debt cycle has turned the corner into a
new phase, and it is more likely than not that
during twenty twenty four, when the federal reserve cuts interest

(14:47):
rates that will spark a reignition of inflation because the
government will be able to borrow and spend so much more,
And then the rates on all the other debt that
you and I care about will actually go up as
a result. And if your interest in creating a portfolio
that is protected from crazy moves like this in interest
rates and the results that this will have on other
asset classes like the stock market and real estate, join

(15:10):
hundreds of other members of Haresy Financial University that are
learning to do exactly this, because in the coming financial storms,
there's going to be two types of people. The first
group of people are going to lose a ton of
money in the volatility, in the crashes, in the buying high,
and in the selling love. The other group of people
is going to be sophisticated investors who are prepared, who
are hedged, and who are ready to take advantage of

(15:32):
the opportunities as they come. And nobody wants to be
in that first group, but most people will be, so
don't be part of the crowd. Sign up for Haresy
Financial University linked in the description below. As always, thank
you so much, watching have a great day.