Fed Meeting Makes Life Tricky for Consumers

With no interest rate cut at the latest Fed meeting, see what consumers should expect regarding the recession, savings account rates and loan rates in 2021.
By Richard Barrington

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While the financial community often takes its cues from the actions of the Federal Open Market Committee (FOMC), it seems as though the FOMC is going to be doing the same as most Americans in the weeks ahead - closely watching the progress of COVID-19 vaccinations.

In a release following the December 15-16 FOMC meeting, the Federal Reserve noted that "the path of the economy will depend significantly on the course of the virus."

Since the Fed can't do anything about the virus and its latitude for short-term interest rate cuts is extremely limited, it will focus its efforts on doing what it can to keep long-term rates low.

For consumers, this means there is no clear timetable for an end to the recession. Low rates are likely to continue for the foreseeable future, but tightening credit standards could restrict the number of consumers who can benefit from those low rates.

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Fed Interest Rates and the Recession

The Fed's go-to move for fighting a recession is to lower short-term interest rates. However, having kept the Fed rate unusually low during the last economic expansion, there was little latitude for fed rate cuts going into this recession.

With the fed funds rate having been lowered to a range of 0 to 0.25% back in mid-March, there isn't really any room for further cuts in short-term rates. However, what the Fed can do is attempt to influence long-term interest rates by buying fixed income securities on the open market.

At the conclusion of its most recent meeting, the FOMC announced that it would continue to buy Treasury and mortgage-backed securities each month. This type of activity has likely been a factor in driving mortgage rates down to record lows recently.

The Fed's tactic of keeping both short- and long-term rates low is part of a broader effort to keep credit accessible to American consumers, businesses and institutions. However, that broader effort will be restricted somewhat by a recent decision by the U.S. Treasury.

The Treasury has been providing the Fed with funding to make emergency lending available if necessary. However, the Treasury announced last month that this program will expire at the end of 2020.

This means that even though interest rates may remain fairly low, lenders may tighten their standards if credit becomes scarce. In fact, the combination of a lingering recession with low interest rates could make lenders especially reluctant to make loans.

For consumers, this environment has different implications depending on whether you are saving money or looking to borrow. The impact on each situation is discussed below.

Outlook for Savers After the FOMC Meeting

Savers don't have to worry about the availability of credit, but the rewards for saving are reduced by low interest rates.

By the third quarter of 2020, the average rate on savings accounts was less than half what it was at the end of 2019. Money market accounts and CDs had also experienced steep drops in rates.

This would mean earning a lot less on your bank deposits, but for most bank customers there are moves you can make to actually earn more in this falling rate environment.

Long-term CDs still offer a higher yield than savings accounts, money market accounts and short-term CDs. So, if you don't expect to access some or all or your deposits in the near future, consider switching to a 5-year CD at the next opportunity.

Whether you choose a CD or stick with a savings or money market account, be sure to shop actively for better rates. The top tier of rates available is significantly higher than the average, which means most consumers could earn more with a little smart shopping.

One other impact of low interest rates is that it could lower returns on long-term retirement savings. This is partly because low rates mean low yields on the bond portion of retirement plans. It's also because low rates have driven the stock market up to high valuations, which usually mean lower returns going forward.

Because of that, this might be a good time to lower the return assumption you use in retirement planning. Doing so could give you a more realistic picture of how much you need to save to fund your retirement.

Outlook for Borrowers

Borrowers would seem to be the winners in a low interest rate environment. That's true, as long as you can get credit.

The longer the recession continues, the more lenders are likely to tighten their standards for who can get credit. After all, the more people are in financial difficulty, the riskier lending becomes.

Ironically, while the Fed is keeping interest rates unusually low in an attempt to make sure people can still borrow, those low rates may give lenders less incentive to make loans in a risky economic environment.

What this means is that, if you plan on taking advantage of low loan rates in the months ahead, focus on keeping your credit score as strong as possible.

Also note that, while all the signs from the Fed are that it plans on keeping interest rates low for a long time, the distributions of vaccines make this a very dynamic situation. It would be risky to count too much on stability in the year ahead.

Previous Federal Reserve Board Updates articles:

FOMC Date2020 FOMC Meeting Update Articles
11/06/2020What Consumers Can Do as Fed Keeps Rates Near Zero
09/17/2020The Fed's New Tolerance for Inflation Could be Trouble for Consumers
07/30/2020Fed Rate Unchanged: What Consumers Should Do
06/11/2020With No Rate Cut from the Fed, Now It's Your Move
04/30/2020How Will the Latest Fed Meeting Affect Consumers?
03/19/2020Fed Moves Show Urgency of Coronavirus Response
01/30/2020Fed Rate Decision Means Consumers Have a Choice

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