Solutions Economic and Market Watch

Welcome to the Economic and Market Watch podcast for the week of September 29, 2025. This is Antony Davies.

Two weeks ago, the Fed cut interest rates for the first time since last December. Even with this 25-basis point cut, the Fed funds rate remains 400 basis points higher than before the unpleasantness of 2022 when the Fed was scrambling to get inflation under control. Currently, futures markets show a 98% chance of at least one more cut by the end of the year and an 80% chance of two cuts.

Every time the Fed cuts rates, people ask me why they aren't seeing mortgage rates fall. The answer is that the Fed influences the shortest of short-term rates: the Fed funds rate. This is the interest rate banks charge when they loan each other money overnight.

The shorter term an interest rate is, the more closely it will follow changes in the Fed funds rate. The longer term it is, the less closely it will follow.

For example, since 2021, changes in six-month treasury yields have matched changes in the Fed funds rate almost one for one on average. But changes in ten-year treasury yields have averaged less than half the size of corresponding changes in the Fed funds rate.

Before 2008, the Fed kept a tight leash on market liquidity and longer-term rates tended to be more responsive to Fed policy. Since 2020, the Fed has adopted a much looser stance on market liquidity, and this has softened the link with longer-term rates. One consequence is that now long-term rates largely depend on demand for long-term loans.

This means that we can't necessarily expect the Fed's cut to bring good news to mortgage borrowers, but it is possible it could bring bad news.

Here's why. Long-term rates are sensitive to inflation expectations. Lenders want to be compensated for the purchasing power inflation is going to drain from their investment. So the higher is inflation, the greater is the interest rate lenders will demand.

And this brings us back to the recent Fed cut.

When the Fed cuts short-term rates, banks have an increased incentive to create loans. As they create more loans, the money supply expands.

If the economy grows proportionally with the money supply, there's no problem. But if something holds the economy back — like, for example, a change in tariff policy or low consumer sentiment — then the economy could end up growing more slowly than the money supply, and that will put upward pressure on inflation.

The end result is that a cut in short-term rates can, given the right conditions, actually lead to an increase in long-term rates. The unknown factor is what the economy will do. To look at financial markets, appears that the economy is booming. The Nasdaq is up 30% year over year and the S&P 500 is up 20%. These are performances more akin to the dot-com boom of the 1990s than to the doldrums of recession.

But consumer sentiment tells a very different story. The University of Michigan's Consumer Sentiment Index has steadily fallen since January and is now in the low 50s. Historically, the index averages 70 during recession. To look at consumers, today's economy is worse than during the financial crisis of 2008. The fundamentals tell a different story still. Unemployment is rising but significantly less than the pre-COVID average. Economic growth is tepid but not recessionary. To look at the fundamentals, today's economy is somewhere between "not that bad and not that great. In cutting its target interest rate, the Fed is betting that the economy is leaning more toward "not that great." And regardless of what the economy is actually doing, the psychological effect of a long-awaited rate cut might perk up consumers. In perking up, they might bring about the stronger economy the Fed hopes is lurking out there.

Either way, expect the Fed's rate cut to have an effect on short-term interest rates. Hope that it has a positive effect on economic growth — But don't expect it to do too much to long-term rates.

This is Antony Davies for the Economic and Market Watch podcast. Thank you for listening. Download the weekly Economic and Market Watch intelligence brief and dashboard and send us that sweet email at economicresearch@nrucfc.coop.