By Andrew Miller
The Federal Reserve’s policy meeting kicks off today, with a decision on interest rates due tomorrow afternoon.
On paper, there’s a strong case for leaving rates alone.
Inflation dropped to 3.5% in June. Jobless claims just hit their lowest level since 1969. Both of those numbers bode well for the Fed’s responsibility of balancing employment and price stability.
However, there’s a more pressing issue lurking beneath the economy’s surface.
Each year, the U.S. government issues $2 trillion in new Treasury bills and bonds alongside a growing budget deficit. This deficit is nothing new. It’s been happening for two decades. The problem is that it keeps growing even as the economy holds up.
When the government borrows this much, it has to make its debt attractive enough that investors keep buying it. This pushes up the return those investors demand.
Banks use that return as a baseline for what they charge on mortgages, auto loans, and business credit. That return can push borrowing costs higher on its own.
That’s the bind the Fed is in. Its job is to set interest rates based on jobs and inflation. But the deficit itself, a responsibility that falls to Congress, can increase borrowing costs even if the Fed’s decision tomorrow goes as expected.
According to the futures markets, the odds of the Fed holding rates unchanged tomorrow are 64%. However, the odds of a rate hike at the following meeting in September sit at 80%.
While a rate hike would certainly raise borrowing costs, that’s not the only thing to watch. Treasury debt is already putting pressure on those same costs, regardless of what the Fed decides tomorrow.
P.S. Borrowing costs don’t wait for a Fed announcement to move. If you’re weighing financing, now’s a good time to talk it through with us.