Federal Reserve’s December Decision: How Does it Affect Panamanian Wallets

Panama City: The United States Federal Reserve System will make its last monetary decision of the year early next week, an event with a domino effect that directly impacts the Panamanian economy.  Market analysts expect the Fed to continue cutting its benchmark interest rate, in this case by about a quarter of a percentage point. And this downward trend should ease the financial pressure on Panama, but other factors could play against it. The Federal Reserve System—through its Open Market Committee—adjusts its interest rate eight times a year in order to fulfill what is called its dual mandate. On the one hand, the Fed must increase the quantity of dollars in such a way that its spending stimulates job creation. Jerome Powell Chairman of the Federal reservice is pictured below:

And, on the other hand, it must prevent the price level from skyrocketing.  Central banks around the world, including the Federal Reserve, have reached a consensus that the optimal inflation rate to meet this dual mandate is 2%, a figure first computed by economists at the National Bank of New Zealand in the late 1980s. By varying its reference interest rate – in fact, a range of rates – the US Federal Reserve, through multiple mechanisms, controls the amount of dollars in circulation. This has a direct impact on the inflation rate.  As the cost of goods soared around the world following Russia’s invasion of Ukraine, which disrupted supply chains for many foods, the Federal Reserve raised its interest rate from zero to 5.5 percent in less than two years, the steepest hike in 20 years. The Federal Reserve Building in the US is pictured below: 

Such a move would have helped limit US year-on-year inflation to 9% in June 2022, with inflation gradually falling to 3% a year later in June 2023, and then to 2.4% last September. Since then, US year-on-year inflation has risen to 2.7%.  This notable drop in the inflation rate is what has motivated the Federal Reserve, towards the end of the current year, to reduce its interest rate, going from 5.5% to 4.5%, for now.  Panama’s banking system is largely aligned with U.S. financial trends. Studies by both the Panamanian Superintendency of Banks and the public database El Tabulario indicate that there is a delay of about six months between the moment the Federal Reserve changes its interest rate and the moment when an effect is noticed on the level of rates in Panama. 

This means that the current level of financial pressure caused specifically by the Federal Reserve rate should last at least until the end of the first quarter of 2025, next March.  However, the weakening of the financial position of the Panamanian State and the National Treasury, already described in detail by the three main rating agencies in the world, generates new elements of financial pressure that could deny lower rates at a local level once the weight of the US rate is alleviated.  This weakening is being driven by the growing fiscal rigidity of the State, the unfinished situation of the copper mine in Donoso and the delicate condition of the Social Security Fund. 

And the risks of this new financial pressure will leave home buyers, mortgage holders, entrepreneurs and businesses facing a complex outlook by the middle of next year.  However, one of the main expectations, in view of this difficult outlook, is that the stability that the beginning of the first full year of the new government can provide will serve to support the local economic movement.  Every quarter, the Superintendency of Banks of Panama computes the reference rate for the local mortgage market, based on the rates charged by banks with the largest mortgage portfolios.  Federal Reserve Board of Directors meeting shown below:

Between 2000 and 2009, before Panama obtained investment grade status, the mortgage reference rate averaged 7.9% per quarter.  Between 2010 and 2020, since Panama obtained investment grade until the COVID-19 pandemic, the mortgage reference rate registered a quarterly average of 5.8%.  This drop represents a reduction of more than $200 per month in the mortgage payment for a $150,000 property, not adjusted for inflation.  In fact, the mortgage benchmark rate hit its lowest level in the first quarter of 2016, when it stood at 5.25%. It stayed at that level until 2018, when it rose to 5.5%. It then increased to 5.75% in 2019 and jumped to 6% in 2023. And in the current quarter, it is computed at 6.25%.