The Federal Reserve recently threw financial markets for a bit of a loop. The central bank announced that it was cutting the Fed Funds rate back to zero in a move that was not totally unexpected. The central bank’s timing, however, was another subject of debate, as the Fed acted in between its regularly scheduled policy meetings. Perhaps the central bank saw the need for immediate policy action which could not afford to wait for a few days.
Whatever the case may be, the Fed Funds rate back at zero should, in theory, drag other interest rates lower, from mortgages to credit cards. Many interest rates charged for major credit sources such as credit cards and mortgages are based on the yield of the benchmark 10-year note. The note’s yield recently dipped under one percent, and the entire U.S. yield curve is now yielding less than two percent.
Lower benchmark yields may save money for many consumers. Those carrying credit card balances, for example, could see the interest rates they are paying decline by a few percentage points. Those who have adjustable rate mortgages could also potentially benefit if their mortgage is set to readjust while rates are lower.
A zero Fed Funds rate is not great for everyone, however, and some have argued it could do more harm than good. For those who do not carry debt, there may not be much upside. On the contrary, a lower key interest rate may significantly lower the yield on savings accounts and other investment vehicles. This lower yield can have a large impact on retirees, who may depend on interest income in order to pay expenses.
Despite the Fed’s aggressive actions, however, the rates that consumers pay are not likely to change too much. The Fed Funds rate is the rate of interest that banks and financial institutions pay each other, and regular businesses and consumers are unlikely to be able to borrow at rates anywhere near the Fed Funds rate.
The Fed is looking to keep the economy running during the coronavirus pandemic. Lower rates may encourage businesses and individuals to borrow, expand or take other economic risks. These activities all serve to keep the economy running. Lower rates may also potentially provide support to stock markets and risk assets that have been hit very hard in recent weeks. With little to nothing to earn on many interest-bearing investments, market participants may prefer to invest in stocks or other risk assets that have the potential to provide a much more meaningful return.
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