Winter Newsletter 2024

As we look ahead to 2024, it is important to reflect on where we have been over the past few years. As we entered 2020, the economy was rolling strong, and interest rates were at very low levels. Then we suddenly became aware of the COVID-19 virus, which changed all our lives. The economy was literally shut down, people stayed home, and only essential businesses were still operating at near full capacity. As a result, our supply chains were severely disrupted, and shortages were commonplace. To address the inability for payrolls to continue, the federal government began injecting funds into the hands of individuals and businesses to keep the economy running. This began the dramatic increase in the federal debt and the issuance of more U.S. Treasury Bonds to fund the spending. To restart the economy, the Federal Reserve significantly lowered the federal funds rate to nearly zero. Since that was not enough to fully accomplish their goals, they began buying U.S. Treasury securities to push longer-term rates down as well. Longer-term rates fall when the Fed begins buying longer-term securities because the supply is decreased, causing other buyers to accept lower rates if they want to buy the limited supply available. This, of course, was happening even with the significant increase in U.S. Treasury issuance to fund the debt.

The combination of labor and material shortages, massive government funding, and record low interest rates resulted in the highest inflation rate since the 1980s. To fight inflation, the Fed responded by sharply raising the benchmark federal funds rates to slow the pace of spending and bring supply and demand back in check. This caused longer-term interest rates to rise to the point that mortgage rates exceeded 8%. This in turn nearly doubled the traditional house payment. Meanwhile, home construction costs were rising due to higher labor and material costs. Although longer-term interest rates followed short-term rates up, the longer-term securities started dropping once inflation rates hit new highs and early signs of recession were seen. As time continued to pass, the yield curve became inverted (short-term rates are higher than long term rates). The bond market is an early indicator of where the economy is heading and where the market expects interest rates to be in the future. At the time of this writing, the federal funds rate is currently at 5.50%, but the 1-year Treasury yield is 4.85%, the 2-year is at 4.32%, the 3-year at 4.04%, the 4-year is at 4.04%, the 5-year is at 3.88%, and the 10-year is at 3.90%. The Treasury yield curve is telling us that rates will fall soon. Additionally, the latest round of economic indicators suggests that consumer spending is slowing, as is the Gross Domestic Product (GDP). These are both indicators that the supply demand balance is beginning to come back into balance, and inflation is declining as the once overwhelming demand has begun to slow and more of the supply issues are getting solved. Just look at your local car lot to see how much inventory has grown over the past year. This is good to see!

At their latest meeting, the Federal Reserve Governors completed what is known as the quarterly “Dot Plot.” This is a plot graph where each voting member of the Federal Reserve Board confidentially indicates where they think the federal funds rate will be over the next several quarters. These guesses are plotted on a graph and released to the public. This last plot indicated that rates could fall as much as 200 basis points (2 percentage points) over the next year. This would bring the short-term rates more in line with the rate indications the bond market is showing us with the inverted yield curve. Although we do not expect rates to fall to the levels they were in 2020, we do expect rates to fall significantly and get more in line with historical trends. Obviously, future economic data could change this outcome, but currently it seems clear that the path is set.

At this time, I would once again like to thank all our loyal customers for your ongoing confidence in us to provide you with quality financial services and a solid commitment to supporting the communities that we operate in. From our beginning in 1998 as a start-up bank, we have now grown to just under $1 billion in total assets. This has given us the financial strength and capacity to provide you with all the services you need in a very safe and secure manner.

Thank you again for a successful 2023, and let’s make 2024 great!
-Mike