A consumer holds a cellphone to his right ear and looks down at papers he’s holding.
The Federal Reserve’s first interest rate cut in more than 10 years has many people questioning the impact on their finances.
A consumer holds a cellphone to his right ear and looks down at papers he’s holding.
The Federal Reserve’s first interest rate cut in more than 10 years has many people questioning the impact on their finances.
Financial Health
August 1, 2019

Fed rate cut: What you need to know

The Federal Reserve’s rate cut — the first in more than 10 years — might not grow the economy as much as previous rate reductions, Wells Fargo economists and investment strategists say. Here are eight ways the rate cut could affect you.

Lower monthly mortgage and credit card payments may be coming soon for some borrowers, thanks to the Federal Reserve’s decision to cut interest rates for the first time in 10 years, Wells Fargo economists and investment strategists say.

On July 31, the Federal Reserve Open Market Committee voted to reduce the federal funds target rate, for the first time since December 2008, from an upper target of 2.50% to 2.25%. This is the rate banks charge each other for loans overnight from their reserve balances, and which, in turn, influences the prime lending rate.

The reduced rate could mean lower payments for those with credit cards, mortgages, and loans with variable interest rates, but could have little to no impact for borrowers with loans or credit cards pegged to fixed interest rates, said Tim Quinlan, senior economist for Wells Fargo Securities. For savers, he said, reductions mean less interest earned on cash held in certificates of deposit, money market accounts, and regular savings accounts.

The potential good news for borrowers comes with a word of caution: The rate cut — and its impact to rate-sensitive products — might also spur less economic growth than previous cuts, Wells Fargo professionals say.

“Why cut rates now, when unemployment is at a near-record low, consumer spending is already strong, and the stock market at a near-record high? The simple answer is that the global economy is showing signs of serious strain amid the ongoing trade war, and inflation has been too low for too long,” Quinlan said.

Rate cut strategy and risks

Fed policymaking seeks to keep inflation low and stable and foster an economy with maximum employment, said Luis Alvarado, an investment strategy analyst for Wells Fargo Investment Institute.

“Overall, what the Fed is trying to do is to bolster the strength of the economy and to keep it humming for a longer period of time,” Alvarado said.

This latest rate cut comes after nine consecutive increases — between Dec. 17, 2015, and Dec. 19, 2018 a period where the rate has gone from 0.25% to 2.5%. The move also comes amid international trade tensions and slowing global growth, and when its preferred inflation barometer, the Core PCE deflator — which measures increases in prices consumers pay for goods and services, except highly volatile food and energy, to flag inflation trends — is at a near record low (just 1.6% in May).

See text drawer
Source: Federal Reserve website

“During the dot-com boom and subsequent bust from 1994 to 2000, there were questions about whether the Fed had some culpability in inflating the bubble in tech stocks by not tightening faster to rein in the ‘irrational exuberance’ evident at the time,” Quinlan said.

Rate cuts often have another byproduct — higher consumer spending. That might not happen this time around, Quinlan said, since consumer spending already is strong.

The rate cut strategy also brings potential risks because inflation rates are so low, he added.

“It hinders the Fed’s ability to cut real (inflation-adjusted) rates to deal with the next recession,” Quinlan said.

With the first Fed cut in years coming after so many increases, Alvarado said a single cut might not move the market significantly, and could contribute to market volatility.

“Our expectation is that the Fed could hint at another rate cut in the coming months, and the markets could be choppy ahead during this adjustment period,” Alvarado said.

8 ways the rate cut could affect investors

Lower mortgage and credit card payments. Consumers with adjustable-rate mortgages or credit card debt tied to variable rates may find themselves with more money to spend, Quinlan said, though this rate reduction’s impact may be more muted than the financial crisis of 2008.

Little relief for student and auto loans. The Fed’s action offers little relief for borrowers with the student and auto loans that account for nearly all of the increase in household debt, Quinlan said. That’s because most of those loans have fixed rates.

Favorable borrowing terms. “Rate cuts are viewed as a catalyst for growth, and lower rates allow for more financial flexibility and more favorable borrowing terms,” said Jennifer Kane, a financial advisor with Wells Fargo Advisors in Houston.

Strong stock performance. “Historically, stocks have performed well in an environment where the Fed is cutting rates,” Kane said. “I believe the health care sector is one that may outperform in the subsequent months, in part due to their higher dividend payout on average.”

Potentially more benefits for growth stocks than value stocks. “Growth stocks typically get their value from cash flows that might happen in the distant future, and when rates decline, their values can go up,” said Kirk Hartman, president and global chief investment officer for Wells Fargo Asset Management. “They can also benefit if investors perceive that a rate cut by the Fed is more about extending the economic expansion than about cushioning an economic downturn. As a result, we expect that rate cuts could put a little wind in the sails of the shares of growth stocks.”

A boost for tech stocks. Good examples of growth stocks that may benefit, Hartman said, include technology stocks and “‘asset-lite’ companies, which have fewer physical assets and can, therefore, scale more rapidly, taking maximum advantage of the reduced cost of capital.”

Impacts on savings. Given the impact to interest that typically follows within a month of a Fed rate cut, Kane said, those “with money in savings, money market, and other accounts could consider moving their cash ahead of those changes into savings vehicles offering a fixed yield to maturity, like certificates of deposit.” Each type of cash alternatives has advantages and disadvantages which should be discussed with a financial advisor before investing.

Business as usual for investors. Instead of focusing on short-term market and interest-rate movements, Alvarado said, Wells Fargo Investment Institute continues to favor the long view, including the wisdom of a diversified portfolio and “to monitor portfolios for opportunities to rebalance.”


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