October, 2019 - What The Latest Fed-Rate Cut Means to You
FEDERAL-FUNDS-RATE TARGET: 1.5 to 1.75%
Some are referring to the latest Federal Reserve interest-rate cut as a form of insurance - a preemptive move to protect the economy from recession. Like any form of insurance, this move does not come without costs that consumers should understand.
The Latest Fed-Rate Cut - Why It Happened
The Federal Open Market Committee (FOMC), which is a subset of the Federal Reserve, cuts rates when it thinks the economy needs a boost.
The FOMC may take this action when the economy is in a recession. It might also cut rates as a precaution, to try to prevent the economy from slipping into recession.
The latter is the case this time around. The U.S. economy is not in a recession, but fears of a recession sometime in the next year or so are growing.
Since the end of World War II, the average economic expansion has lasted about five years. The current one has lasted more than ten years. This suggests the economy is overdue for a recession, and there are signs this expansion is running out of steam.
Hours before the announcement about the federal funds rate, the Bureau of Economic Analysis announced that the U.S. economy grew at a real annual rate of 1.9% during the third quarter of 2019. That 1.9% growth rate comes after the economy grew at a 3.1% rate in the first quarter and then a 2.0% rate in the second quarter - not an encouraging trend.
Also, while the unemployment rate remains low, 2019 is on track to be the slowest year for job growth since 2010, when the economy was staggering to recover from the Great Recession.
Can the Fed-Rate Cut Ease Recession Fears?
With signs that expansion is losing momentum, economists have started talking about the possibility of a recession in the next year or so. This concern is the context in which the Fed announced a quarter-point rate cut on October 30, the third such cut in as many FOMC meetings.
Will this provide the insurance against recession for which many are hoping? There are reasons to question how effective the rate cut will be this time around:
- Fed rates are already very low compared to normal levels. If low rates haven't helped so far, will another rate cut really make a difference?
- The economy is awash in debt. Rate cuts are supposed to stimulate the economy by making borrowing more attractive. However, with mortgage debt, student loan debt, auto loan debt and credit card debt already at or near record highs, how much more appetite for borrowing is there?
No doubt the FOMC is well aware of these points but considers a rate cut its best course of action anyway. That's reason to take fear of a recession seriously, because the Fed obviously does.
What the Fed-Rate Cut Means to You
Cuts to the fed funds rate mean very different things to savers than to borrowers. This time around, though, the news isn't very good for either group.
What the fed-rate cut means for savers
Unfortunately, trying to boost the economy by cutting interest rates is like a tax on savers. This is especially true when rates are already unusually low.
Savers have already seen interest rates on savings accounts, money market accounts and CDs start to slip. This is partly because of fed-rate cuts, but also because of the general concern that the economy is weakening.
Average rates on deposit accounts are already below the rate of inflation, and they may fall further behind. However, there are a couple things you could do to fight back:
- Raise your rate in a falling-rate environment. A few leading banks offer deposit rates well above average. This means that, even with rates falling, most customers have the opportunity to find higher rates.
- Consider moving some savings to a long-term CD. CD rates are generally higher than rates on savings and money market accounts, especially if you can commit your money for a few years. This only makes sense if you don't need the money any time soon; but if that's the case, a long-term CD can both earn you a higher rate and help shield you from further rate cuts.
Another drawback to the rate cut for savers is that lower rates can make long-term retirement saving goals harder to meet. This would be a good time to revisit your retirement-fund-return assumptions on a retirement calculator, and make sure those assumptions are in line with the current rate environment.
What the fed-rate cut means for borrowers
It's easy to assume that lower rates are good for borrowers. After all, they make borrowing cheaper, so what's the catch?
The problem is that rates are falling because the economy is generally viewed as getting weaker. This does not make for a good borrowing environment for two reasons:
- Credit might be tough to come by in a weakening economy. Consumer debt levels are already at record highs. If the economy is getting shaky, lenders are likely to become more cautious about lending.
- You should think long and hard about taking on new debt in a weakening economy. A weak economy can put millions of jobs at risk. This may not be the best time to be taking on an additional monthly payment.
Bottom line, one can hope the fed-rate cut ultimately helps the economy at large because, in the meantime, it isn't particularly good news for either savers or borrowers.
Previous Federal Reserve Board Updates articles:
|FOMC Date||2019 FOMC Meeting Update Articles|
|08/01/2019||July 2019 Fed Meeting Raises New Questions|
|06/20/2019||Consumers Not Limited by Fed's Rate Decision|
|05/2/2019||Federal Reserve Pursues Rate Stability|
|03/21/2019||Shifting Stance: Fed Implies No Rate Increases in 2019|
|1/31/2019||Fed's Low Profile Won't Stop Interest Rates from Rising|