Fed Cuts Rates – What Does it Mean for Consumers?
American consumers and businesses have enjoyed an unprecedented run of low interest rates for a decade, thanks to the maneuverings of the The Federal Reserve, in the wake of The Great Recession that began in 2008. Low lending costs have spurred spending and growth, which helped the economy recover.
The Fed had signaled the intent to continue raising rates in 2019, and the prognosticators busily forecasted the impact of rising rates on housing, financial markets, and other industries. However, in a U-turn based on inflation fears, the Federal Reserve instead cut rates for the first time in over 10 years.
What does this mean for consumers and home buyers?
Contrary to popular belief, Fed actions don’t typically directly impact mortgage rates. Mortgage rates are tied to long-term Treasury yields, such as the 10-year Treasury bond. Of course, government borrowing in the form of Treasuries can be impacted somewhat by Fed actions, but since the Treasuries trade on the bond market, they are also subject to the forces of supply and demand and other factors. It’s a complex relationship.
Mortgage rates are already below 4% for 30-year and 15-year mortgages. While they could go lower, it’s unlikely that there will be an immediate change in rates based on Fed rate adjustments. Other factors, such as forecasts for housing and demand for mortgages can also impact rates.
Unlike mortgages, many major credit cards are tied to the “Prime Rate”, which is the best rate that banks offer their best clients (i.e. those with excellent credit). The Prime Rate is impacted by changes to the Fed Funds lending rate, which is the rate banks charge each other for overnight loans to meet Federal Reserve requirements. So if you have a lot of credit card debt, you may see some adjustment in the APR, based on the recent rate cut. If you have a lot of credit card debt, you may see a little relief here thanks to the interest rate cut. It could take a billing cycle or two for you to see this impact on your monthly statement.
So how much relief could consumers get? Likely not much. On a $1,500 balance, at a 14.5% APR, the savings on the finance charges would be reduced by less than 50 cents per month. Of course, spread across all US consumers, which have roughly $8,500 in revolving debt on average, the collective savings is around $1.5 billion for a 1/4 point rate cut.
Of course, if you are one of those relatively rare individuals with a fixed-rate APR, then you won’t see any adjustment in rates at all.
Saving accounts are where consumers may feel the greatest impact. The yield on savings accounts are directly tied to Fed rates, and are already excruciatingly low. Online-only banks pay a slightly better yield than traditional brick and mortar banks, but even those are expected to drop as much as 0.11%. Many brick and mortar banks already pay less than 1% for deposits (about 0.28%, on average).
If you are sensitive to interest rates or rely on interest income, then your best bet may be an online-only savings account. Some of these are still paying around 2% interest.
The impact to investments is somewhat difficult to quantify, since it depends on the investment vehicle and the industry. For instance, banks and brokerages are particularly sensitive to interest rate changes, because part of their profit is based on the “margins” – i.e., the difference between the interest rates they have to pay on deposits, and the interest the collect from lending activities. When these margins are small, such as when Fed rates approach zero, these firms are squeezed. However, other businesses may use a reduction in borrowing costs to invest or expand in their companies, which can have a positive impact on overall valuations.
The Federal Reserve really can’t go much lower, without hitting zero or negative rates. It will be interesting to see how this plays out in the long term. President Trump is a big fan of keeping rates low, and has been pushing the Federal Reserve to go even lower. Whether they cave to the pressure or not remains to be seen.
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