So, yesterday the Federal Reserve announced an aggressive rate cut, bringing the Fed Funds rate down to pretty much 0 (the target rate is now 0 - 0.25). This has continued a trend of Fed intervention and interest rate cuts for the past couple of years and has certainly sparked a lot of debate. Some think that the Fed cutting rates is bad for the economy since we’re already piled up in corporate debt, bond yields are at all-time lows, and these rate cuts haven’t even done much to boost markets. However, on the other end, some people believe the Fed is doing what is necessary to keep our economy afloat in a time of crisis, and further ensuring that we don’t dive right into a recession.
See, the thing is, I can recite all of the stuff that I just talked about, but a lot of people don’t really even understand what it means. So because of this, I’m going to do the best I can to break down the nature of Fed rate cuts and what it means for everyday people.
First things first, if you’re unfamiliar, the Federal Reserve oversees monetary policy, they regulate the banks and the financial system. The Fed has the power to move the Fed Funds rate, which in turn impacts the cost at which banks can borrow money (lower rates = cheaper money), and then the banks determine what they charge consumers based on the benchmark rate that the Fed determines. Think of this scenario as a car (the car itself is the economy and interest rates are the gas pedal) when the Fed lowers rates, they are essentially trying to speed up the economy by pressing down on the gas pedal. When rates are low, borrowing is much cheaper, and so more people are going to have an incentive to dump money into the economy. One small example could be the cost of your mortgage. When the Fed Funds rate (the benchmark rate) is low, the interest charged on mortgage financing will often be lower, this incentivizes people to either go get a mortgage or to refinance their already pre-existing loan.
On the other hand, when the Fed increases rates, they are pulling off of the gas pedal and trying to slow the economy down. In another small example, if interest rates are higher - the rate of interest you see in your savings account will be much higher as well. This gives you an incentive to take your money and put it into safe holdings like a savings/money market account.
So, at first, it may not seem as though it circles around to impacting everyday people, but it does and in a variety of ways.
I mentioned how it impacts everyday people in small ways like mortgages or savings, but interest rates impact us all in much more significant ways too - ways that we may not always realize.
For example, when the Fed cuts interest rates as they have been, this often assists small and large companies by giving them easier access to capital. In turn, this helps keep the overall economy flowing; if companies can’t access money, then they start to fail, and when companies fail, the economy fails along with them. On top of that, businesses employ people just like you and me. When businesses can’t access capital, one of the first things they start to do is to lay off employees and I think we can all agree that getting laid off isn’t a good thing.
At the end of the day, the theme of what I'm trying to get across here is that a simple thing like the Fed Funds rate can trickle down to impacting big companies/corporations while also impacting our mortgage rates, our savings accounts, the financial markets and potentially even our jobs.
When events like the coronavirus happen, the Fed is pretty much forced to act, and in this case, they lowered rates down to zero for this first time since the 08’ crisis. While I don’t think it’s time to panic, this is something to take seriously, and yes, I know these things can seem complicated, but as long as you take the initiative to inform yourself, you’re on the right track.
I hope you guys learned something and feel free to DM our social media accounts @finxmobile if you have any questions about what is going on, we’d be happy to help.
See you all next time.