FEDERAL-FUNDS-RATE TARGET: 2.0 to 2.25%
The Federal Reserve's July 30-31st meeting took place amid widespread speculation that the Fed was reaching a turning point in its rate policy.
It did not disappoint that expectation.
However, the apparent turning point from Fed rate hikes to rate cuts raises some important new questions.
July 2019 FOMC meeting recap
The Federal Open Market Committee (FOMC) voted to cut the Fed's interest-rate target by a quarter of a point, to a range of between 2.0 and 2.25%.
This marks the reversal of a policy that saw nine consecutive fed rate hikes dating back to 2015.
Fed rate hikes are an indication that the Fed is optimistic about economic growth, while a fed rate cut indicates pessimism.
When the Fed increases rates, it is signaling that it believes growth can continue despite higher borrowing costs, and raising rates can keep inflation in check. (Rising inflation can be a by-product of strong economic growth.)
In contrast, fed rate cuts make it cheaper for banks, businesses and individuals to access credit. This can spark spending and give the economy a boost.
Going by the numbers, this may seem like an odd time for a rate cut. The economic expansion has just completed its tenth year. At 3.7%, the unemployment rate is extremely low. And yet, Fed policy comments have increasingly expressed concern over what lies ahead for the economy.
For example, the Fed has noted that slower global growth could create a headwind for the U.S. economy. It has also mentioned the potential for lingering trade wars to hurt economic growth. Plus, while the unemployment rate remains low, sub-par labor market participation and sluggish wage gains mean people have not benefited as much from the strong job market.
When you boil it all down, the Fed seems to be saying that, while things have gone pretty well for the economy so far, it still has concerns about what could happen in the near future. The Fed is taking the position that it is better to anticipate trouble and lower rates to keep the economy humming rather than being forced to jump-start an economy that has suddenly stalled.
Implications of shifting policy - moving from fed rate hikes to rate cuts
In shifting from a long series of fed rate hikes to a rate cut, the Fed may have cast a shadow of uncertainty over its meetings for the remainder of the year, at least. Here are some of the questions left unanswered by the Fed's policy shift from rate hikes to rate cuts:
- How meaningful is the Fed's advance rate guidance?
In recent years, the Fed has made an effort to provide economic projections to give the public some idea of where it sees the economy going. However, the Fed just cut rates even though its year-end projection for the federal funds rate was 2.4%, within the previous target range of 2.25 to 2.50%.
How accurate are the Fed's projections? Read Reality Check: Evaluating the Federal Reserve Board
- What rate options remain for the Fed in the next recession?
Even before this rate cut, the fed funds interest rate was much lower than its historical average on both an absolute and inflation-adjusted basis.
Since rates are already low, how much room will the Fed have to move when the next recession finally starts?
- How much of a concern is the economy's weakness on the heels of a huge tax cut?
Last year kicked off with a huge tax cut. If that tax cut expands the federal budget deficit without being able to provide sustained growth, this could spell double trouble for the economy.
- Is encouraging more borrowing really a good idea?
Lower interest rates make it easier to borrow. However, with several forms of debt - student loans, credit cards, car loans, mortgages - already at or near record levels, is making it easier to borrow really good medicine for the economy?
The impact on savings, money market and CD rates
Rates on bank deposit products have been rising steadily over the past couple years. Does a shift toward a lower rate by the Fed mean that consumers will start to see their deposit rates fall again?
Here are some reasons a fed rate cut does not necessarily bring lower rates on savings accounts, money market accounts and CDs:
- The Fed does not directly control deposit rates
Banks set rates based on many factors besides the fed interest rate, so a cut in that rate does not necessarily mean consumers will see the rate paid on deposits go down.
After all, as the Fed raised rates by a total of 2.25% in recent years, the average savings account rate rose by just over a quarter of a percent. So, there isn't always a one-to-one relationship between the Fed's rate changes and deposit rate changes.
- Banks that have been slow to react to rising rates will be least affected
Some banks have been especially slow to raise rates. The latest MoneyRates.com America's Best Rates survey found that over half the savings accounts in the survey still offer rates of just 0.10% or lower. Since these rates have been near zero all along, there is little room for them to fall now that the Fed has cut rates.
- Even if rate increases have peaked, most consumers can still improve their rates
The good news is that the gap between the top deposit rates and the average has been growing recent years. This means that most bank customers still have plenty of opportunity to find a higher rate.
Ultimately, many of the things the Fed reacts to also influence bank rates. So, if the economy really is slowing, expect bank rates to trend down over time. However, even with a fed rate cut, there are still ways to get better rates for the time being.
Previous Federal Reserve Board Updates articles:
|FOMC Date||2019 FOMC Meeting Update Articles|
|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|