In a rather surprising move, the Fed cut its benchmark interest rate by 0.50%, bringing it down to a range of 4.75% to 5.00%. Most were expecting a 0.25% cut. Does it indicate a serious problem with the economy? How will this rate cut affect home loans, auto loans, and credit cards? Is such a substantial cut, just before an election, politically motivated?
Rate Cut and the Economy
Immediately after the Fed announced the rate cut, stocks rose on the news. Then, just as fast, stocks fell, indicating some confusion amongst investors. Now that the dust has settled, stocks are higher. Does this larger-than-expected rate cut indicate a problem with the economy?
According to Fed Chair Powell, “The labor mkt is growing at a strong pace.” Even so, unemployment is slightly higher, but that is largely due to immigration. With the large influx of immigrants, there are more people seeking jobs, pushing the unemployment rate up. Inflation is falling, but prices remain elevated. Overall, the economy has proven to be quite resilient. Therefore, it’s likely the Fed is simply trying to get ahead of the inflation struggle, which is why it cut by 0.50%.
Mortgage Rates
I’ve heard it reported on a few news sites that if the Fed were to cut interest rates (which of course it did), it would translate into lower mortgage rates. This is largely untrue. Fixed rate mortgages are closely tied to the rate on the 10-year Treasury and are unaffected by a change in the fed’s short-term rate. However, there is an exception. Home equity loans and variable interest loans do share a relationship with short-term rates and may benefit from the cut.
Auto Loan Rates
A rate cut by the Fed is helpful to auto loans as these loans are tied to shorter term rates. Automobile loans from commercial banks are down about 7.5% from their high on October 5, 2022. Thus, the Fed’s rate cut should reduce auto loan rates and could spur additional growth in this area. However, according to Kelley Blue Book, auto loan rates may be the slowest to move. Why? Because of the lagging effect of interest rate changes. Specifically, now that the Fed has cut its short-term rate, the prime rate will follow. Since many loans are tied to the prime rate, auto loan rates may be slower to adjust.
Credit Card Rates
Will the rate on credit cards move lower? According to Jonathan Smoke, Chief Economist with Cox Automotive, “Consumers should see more immediate changes in the rates charged on credit cards, which should help improve the financial status of consumers who have built up balances to maintain spending.”
Is the Feds Rate Cut Politically Motivated?
The short answer is not likely. I put this issue to the test a few years ago while attending a Fed conference in Jackson Hole, Wyoming. I asked two sitting Fed presidents, Dennis Lockhart (Atlanta) and Charlie Evans (Chicago), how fiscal policy, which is under the purview of the federal government, might influence their decisions on monetary policy. Without hesitation, each said the Fed stays in its own lane (i.e. monetary policy) and did not comment on or consider fiscal policy in its decisions.
Today’s Fed seems to be more willing to comment on fiscal policy’s effect on the economy and has suggested several times that federal government spending is too high. You see, excessive federal government spending tends to stimulate the economy, which is what the Fed has been trying to avoid. While it’s not uncommon, the federal government and the Fed are once again working against each other. While the Fed is trying to slow the economy to bring inflation down, the federal government is in campaign mode, spending excessively, which stimulates economic growth.
This rate cut does not seem to indicate a problem with the economy. While the 0.50% cut will help auto loan and credit card rates, the benefit to the mortgage market will be limited to home equity lines of credit (HELOC) and adjustable-rate mortgages.
Finally, it’s unlikely this move was politically motivated. Powell was appointed to the Federal Reserve Board of Governors by President Obama (2012), then to the Chair position by President Trump (2018). He was renominated by President Biden. Powell is a Republican.