Fed Approves Rate Cut: What’s Next for Lower Rates?
Today, the FOMC decided to cut rates by 0.25 percent, as many investors had expected. The next scheduled meetings are October 29-30 and December 10-11. What is the forecast? That’s really too far out to tell but the Fed’s patience with rates over the past few years has been showing. Another move to lower rates before the end of the year could spook the markets and cause stocks to tumble and rates to move even further. The problem with that already is rates can’t really get too much lower.
Federal Open Market Committee
Approximately every six weeks, or eight times per year, the Federal Open Market Committee, or FOMC, holds meetings that ultimately determines the cost of money. What exactly does ‘the cost of money’ mean? The cost of money comes in the form of interest paid to the donor by the borrower. At the conclusion of these meetings an announcement is made immediately following. When the “Fed” does make a move, or perhaps stands pat, it becomes news. Consumers can see a headline that states, “Fed drops key interest rate by 0.25 percent” and then think that mortgage rates also fell by 0.25 percent. But that’s not exactly what happens.
The Fed adjusts the cost of money that banks can charge one another for short term loans. Banks are required to have a certain amount of liquid funds available at the end of every business day to meet cash demands the following day. If a bank sees that reserve funds are going to fall short, it borrows the amount needed to meet reserve requirements from another bank. This is the rate the Fed adjusts.
Let’s now take a deeper look. The Fed’s job is to control the cost of money but also with an eye toward inflation. Making money less expensive for banks encourages banks to issue more loans. At least that’s the theory. In practice that’s not always the case. For 30 year fixed rate loan programs, the Fed won’t directly affect those. Instead, Fed moves provide investors with an insight on what the Fed is thinking.
Lower Rates
If the economy is slowing down the Fed may elect to lower rates to encourage lending. If the Fed thinks the economy is rolling right along and businesses are booming, raising rates to cool down a potential overheated economy is the tack. For loans that are tied to the Wall Street Journal Prime rate, a Fed move will affect those rates. But everything else is an indicator.
When the economy is doing well, investors place more of their funds into stocks or mutual funds. When the economy appears to be slowing down, or at least the Fed thinks the economy will soon slow, investors can pull money out of higher risk stocks and into the safety of bonds, including mortgage bonds. It is this activity that funnels down to a consumer’s mortgage rate.
But that’s where the Fed does have an impact, albeit an indirect one. Investors take clues from Fed actions, or lack thereof, when setting mortgage rates each day. The last time the Fed Funds rate was adjusted was last July by lowering the rate by 0.25 percent which then represented the first time rates have been lowered in more than a decade.
Takeaway
We’re still in near record territory as it is. We’ll just have to see how investors react to today’s move over the next few days but so far there has been little reaction. Because the move was expected, the markets have already priced that move in advance.
