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Fed rate increases not helping consumers

As expected, the Federal Reserve raised its short-term interest rate target by 1/4 percent at the conclusion of its Federal Open Market Committee (FOMC) meeting on March 21, to a range of 1 1/2 to 1 3/4 percent. (The Fed targets a range rather than a specific number to leave itself some room to react to short-term conditions.)

This move is indicative of a steadily changing interest environment which should change how consumers think about their mortgages as well as deposit products like CDs and savings accounts.

Normalizing the Federal Funds Rate

The Fed began to raise rates in December of 2015, after dropping them to extraordinarily low levels in response to the Great Recession. The gradual increase in rates is partly a response to improving economic conditions over the past few years, and partly an effort to return rates to more normal levels.

While the latest move was widely anticipated -- and fit neatly with recent policy -- there were a few question marks leading up to it:

  1. Would rising inflation in recent months argue for a faster pace of rate increases?

  2. On the other hand, would three consecutive months of declining retail sales (seasonally adjusted) argue for delaying further rate increases?

  3. The wild card: Would Jerome Powell, the new Fed Chair, alter the course Janet Yellen had set?

What is normal for the Federal Funds Rate?

If the Fed seems to be maintaining the same course with a new leader at the helm, exactly where is that course heading? More specifically, if the Fed's goal is to normalize rates, what does it consider normal?

One clue can be found in a survey of FOMC members about what they expect the appropriate rate policy to be going forward. This suggests a long-term consensus that rates will be in a range of around 2 3/4 to 3 percent. That fits with recent history: Over the most recent economic cycle prior to this one, Fed rates averaged 2.94 percent.

One Caveat: This view depends on inflation continuing to behave itself. Over the past 50 years, Fed rates have generally been significantly higher, at an average of 5.34 percent. This was largely because of an elevated inflation environment over much of that period.

What this means for consumers

It is generally true that higher rates favor savers while lower rates favor borrowers -- but the Fed does not directly control the rates consumers get on their bank accounts and mortgages. Thus far, since the Fed began raising rates at the end of 2015, mortgage rates have risen by about half a percent while savings account rates have barely budged. CD rates and money market rates haven't done much better.

So far, consumers are getting the worst of rate increases

This is a reminder that banks and lenders are making decisions independently of whatever actions the Fed takes. Consumers would be wise to make similarly independent decisions by shopping for the best interest rates on savings accounts, certificates of deposit, and mortgages.

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