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The Federal Reserve cut interest rates: What does it mean to us?

August 2nd, 2019 8:34 AM by Sam Kader

The Federal Reserve reduced benchmark interest rate Wednesday (7/31/19) for the first
time in more than a decade lowering the Fed funds rate by a quarter-point (25 basis points) to just below 2.25% in an effort to bolster the U.S. economy amid early signs of a global slowdown in China and Europe and uncertainty from President Donald Trump's trade war. The Federal Reserve  Chairman, Jeremy Powell said that there is really nothing in the U.S. economy that presents a prominent near-term threat.  Downside risks are really coming from abroad.  

In addition to the rate reduction, the Fed said it would stop selling off its $3.8 trillion assets in August in another easing move. The Fed bought a large amount of Treasury bonds and mortgage-backed securities in the aftermath of the 2008 financial crisis through it's Quantitative Easing policy to keep interest rates low. The Central bank started to sell some of its holdings in recent months because it did not think that extra stimulus was necessary anymore. Now the Fed is putting this on hold.  

How does it affect me? 

Many consumers are wondering why home loan rates haven't declined by 0.25% in tandem with the Fed action. The Fed Funds Rate (FFR) affects short-term rates on things like Home Equity Like of Credit (HELOCs), credit cards, auto loans and savings deposit.  The FFR has no affect whatsoever on home loan rates. The rate that the Fed reduces is the federal funds rate which is what banks and other financial institutions charge one another for short-term borrowing.

Mortgage rates are driven by pricing and trading action in Mortgage Backed Securities (MBS). Mortgages are actually "turned into or securitized" and are traded just like stocks and bonds. Unlike Fed Funds which only changes every 6 weeks (if at all), MBS can change every minute of every business day. MBS tend to correlate with the direction of U.S. 10-Year Note. The main driver for long-term rates is inflation and inflation expectations. If inflation is forecasted to move higher, rates move higher and the opposite is also true. Another driver for of long-term rates is uncertainty - domestically or overseas. 

Here are some affects that you might see from Fed Funds Rate cut: 

1. Your savings account. Fed funds rate has a direct correlation with average yield on a Certificate of Deposit. 

2. Your mortgage. In November of 2018 as the Fed "appears" to have ended its slow-march of interest-rate increases, rate on a 30-Year mortgage was sightly under 5%. It has since fallen to 3.75%. Since mortgage rates are tied to long-term rates, this rate cuts is probably already fully priced in well in advance.  Historically speaking, mortgage rates do not have much further to fall. In the past half-century, the average 30-year rate has never dipped below 3.3%. 

3. Your spending and borrowing. The impact on the household budget of the rate cut is inconsequential. It's not likely to unleash a flurry of consumer activity. 

4. Your job. The Fed reduced rates now and possibly again this fall as policymakers are trying to reduce the risk that millions of Americans could be thrown out of work due to the prospect of a job-killing recession (not that we haven't  faced a looming lay-off from Boeing already).  


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