What a Fed move to cut rates would mean for you
If predicting what the Federal Reserve is likely to do with interest rates this week is easier than usual, predicting how the markets, the economy and your bank account will react remains a tall task.
The Fed is widely expected on Wednesday to cut rates for the first time since 2008, when the U.S. economy was reeling following the housing crash. The only real question: How much the central bank will cut its short-term interest rate, which, remember, is the only one that the Fed actually controls. (Longer term interest rates are set by banks and the bond market.)
Some think Fed Chairman Jerome Powell, who has voiced growing concerns about the U.S. economy, may push though a hefty 0.50 percentage point cut in the federal funds rate, despite resistance from several other Fed members. But most economists, investors and traders believe a quarter percentage point cut is the most likely outcome.
One reason a Fed rate cut would depart from the usual monetary policy script is that unemployment around the country is at its lowest level in nearly half a century. In fact, it would be only the second time the Fed has lowered interest rates when the percentage of Americans looking for work was below 4% — the last time was in December 2000 after the dotcom stock bubble had popped.
The low inflation that Americans are seeing these days can signal that the economy is not living up to its potential, and that there is room for more workers to find jobs or employed workers to find better-paying ones. Cutting rates even while job growth and the broader economy remain solid — rather than waiting for inflation to spike on its own (or even raising interest rates in anticipation of inflation), as the Fed has been doing slowly for the past two and a half years — would be a big break from past policy. Some experts think it could signal that interest rates will stay lower for much longer than most people have anticipated.
Here’s what a rate cut would would mean for borrowers, savers and investors.
What it means for borrowers
Interest rate moves have traditionally meant the most for borrowers. The point of lowering rates is, after all, to make loans cheaper, so individuals and businesses will borrow and spend. But it’s not clear borrowers, particularly individuals, will see lower lending rates this time around. First of all, most credit cards are no longer based on interest rates, but rather on a person’s credit rating and payment history. That’s why credit card rates have stayed in the teens, even as overall interest rates have been in the low single digits.
Home borrowers do typically get rewarded by lower interest rates. But it’s not clear that will be the case this time around, either. That’s because the 10-year interest rate on government bonds has recently been just above 2%, lower than the Fed’s short-term rate.
Mortgage rates on a 30-year fixed loan have recently averaged 3.8%. If the Fed were to cut rates, boosting the economy, that should cause the rate on benchmark 10-year Treasury bonds to edge up. Mortgage rates typically sit about 1.6 percentage points above the 10-year Treasury, which would put them about where they are now, or perhaps a little bit higher, said long-time interest rate watcher Keith Gumbinger, a vice president at HSH.com.
“There is an upward bias to rates right now,” he said. Home equity loans, on the other hand, which are directly tied to short-term rates, would likely fall.
What it means for savers
The answer for savers is, as with borrowers, much less than you would expect. Some online financial firms and other startup banks have offered savers rates close to the Fed’s short-term interest rate. But that’s not the norm. Most big banks are still paying interest rates on savings accounts that are pretty close to zero, according to Richard Barrington, senior financial analyst at Moneyrates.com.
Bank savings accounts pay an average of 0.44%, according to Barrington’s latest survey. That means rates would have to fall a lot before those saving rates were pressured to fall.
The same holds true for slightly higher money-market rates. On the flip side, Barrington said those higher interest rates from financial services startups are likely to stay high because they are driven by a desire to attract customers, not Fed rates.
What it means for investors
Investors are likely to be cheering the loudest come Wednesday on any rate cut news. Stock prices and interest rates typically move in opposite directions. The relationship doesn’t always hold for individual interest rate moves. For instance, the stock market has generally risen for the past two years, and interest rates have as well.
But if a Fed cut this week signals the start of a longer-term easing cycle, then that should be good for the market, and stock prices will likely continue to climb higher.
The one exception would be banks, which make more money when short-term rates are higher. A rate cut for them would almost certainly mean a lower bottom line for the rest of the year and beyond. That’s likely not good for the stock prices of JPMorgan Chase and rivals, shares of which have mostly been rising this year.
“Interest rates in general will be a headwind for all banks,” says Chris McGratty, a bank analyst at KBW. “Right now bank stocks are trading at a relative valuation that is very, very low.”
Leave a Reply