The U.S. government offices and banks are closed today in observance of Veteran's (Armistice) Day. As such, it seems a perfect occasion for this discussion of interest rates from our friend, AGXIIK.
"Prime Rate and Treasury Rate Divergence", by AGXIIK
This article was initially directed to my business clients and it outlines the differences in the two essential rates used by most small, medium and large businesses.
Last Wednesday: The FOMC drops its fed funds rate by 25 BPS and the Prime Rate drops to 7.75%, down a marginal 25 BPS.
However, The SBA 504 bond rose to 6.28%, up from 6.04% last month
For all intents and purposes that was a 50 BPS divergence in one day.
504 bonds are now up 50 BPS since Sept 2024.
If The Fed is more committed to bringing unemployment down, trying to reduce these high rate impact but not able to eliminate the chance of a recession (my edit: the recession is here and will hit harder in 2025 once the truth comes out about the fact that it started in 2022) the most it can do is slowly drop FRB rates. Large drops do not work well. They scare the big players, causing big market upsets because 50-75 BPS rate drops, frightening investors and borrowers who hear see and smell rough economic conditions coming.
But the Fed's supposed mandate of a 2% inflation target is not as important as low unemployment.
I suspect that Powell, who's likely to remain through 2026 thus be a main driver of Fed policy and will not be subject to Trump's economic policies, is making the adjustments to FRB inflation policy in light of the reality of deeply embedded sticky inflation of 3-5%, part of which is caused by high prime and US treasury rates.
He will likely blink at inflation as a necessary evil as his prime mandate of reducing unemployment and easing rate burdens on all Americans and businesses assumes a predominant Fed policy going forward into 2025.
Unemployment causes huge problems throughout the country. Inflation tags along, eating away at everyone's buying power whether they have a job or not.
Powell is essentially facing the "Damned if you do, damned if you don't dilemma". His thinking is likely to move Fed inflation mandates to 3% plus and drop the rates he can control and let inflation do its Mississippi Leg Hound routine. Mr. Inflation? If he grabs your leg it's best you just let him finish.
Mississippi Leg Hound - Christmas Vacation - YouTube
The US treasury rates still reflect inflation but more importantly they reflect credit risk, the largest of which is $36 trillion in US debt, troublesome CRE debt and large balance loans to weakening public companies.
U.S. National Debt Clock : Real Time
The US treasury has something like $12 trillion plus of new and refi debt coming to market next year. Someone is going to have to buy this and with inflation up, the UST rate has to reflect investor return expectations plus debt risk. US Debt sports a AA rating right now which means investors want a higher yield to mitigate rate risk.
Powell just said inflation is 2.1%. Well golly, I guess the BS runs thick at the Fed because anyone who spends money on anything knows inflation remains 3-5%. I don't listen to what Powell says but what he does.
75 BPS divergence in prime rate and SBA 504 bond rates tells me something's up. These loan rates and programs offered by banks and SBA are a large driver of business financing. That means they're important to millions of SMEs across the land.
8% prime rate 5.75% 504 bond Sept 2024
7.75% prime rate 6.28% 504 bond Nov 2024
That's a big gap of 75 BPS
Will the divergence continue into the future or stop?
My thinking is prime rate will continue to decline with further Powell FRB policy changes.
US treasury rates, the prime driver of my bond rates, will continue to ramp up to compensate for risk.
Locking in 6.28% for 25 years is still a pretty good deal but if prime rate continues to drop into 2025 then a prime rate variable or a 5 year fixed rate loan gives the borrower several 'Get out of Jail Free' Cards.
AGXIIK