The Federal Reserve announced that it’s keeping interest rates steady following its Dec. 15-16 meeting, leaving the federal funds rate at a range of 0 to 0.25 percent. This follows the Fed’s decision to hold rates near zero until the economy has weathered the effects of the coronavirus.
The decision to leave rates alone was widely expected, and it comes while the U.S. is increasingly feeling the effects of a coronavirus-induced slowdown that has thrown millions out of work in record numbers. The Fed has said that highly accommodative monetary policy will continue at extraordinary levels until the country no longer requires it.
“The economic recovery has weakened since the Fed last met, with higher unemployment filings, slower job recovery and softness in consumer spending,” says Greg McBride, CFA, Bankrate chief financial analyst.
The Fed is also watching for more government spending to boost a flagging economy. With Congress divided on the next round of stimulus, it remains unclear how much aid may be injected into the economy and how soon.
“As virus cases mount and coronavirus restrictions return, the lack of additional stimulus from Congress is putting the economic recovery at risk,” says McBride. “Widespread availability of vaccines in 2021 is reason for hope, but we have to get there first.”
The Fed is pursuing a policy of “average inflation targeting,” allowing inflation to run higher than its two percent target following periods of below-target inflation. Over time, the goal is to average about 2 percent. In effect, the policy means that the Fed will likely hold interest rates at near-zero levels for even longer.
The central bank has taken other steps to keep interest rates near its target range, too. The Fed has injected hundreds of billions of dollars into the financial system via repurchase agreements (repo), in which banks exchange securities for cash for a preset time period. The Fed has also been buying Treasury bills at a higher rate, which it will hold on its balance sheet. And it previously announced an unprecedented, unlimited bond-buying program.
All those actions mean low rates are here for the foreseeable future, with varying effects. As the Fed continues to sit tight on rates, here are the winners and losers from the decision.
While the federal funds rate doesn’t really impact mortgage rates, which depend largely on the 10-year Treasury yield, they’re often moving the same way for similar reasons. But in addition to maintaining low rates, the Fed has also become a huge buyer of mortgage-backed securities, helping to steady that market and reduce mortgage rates.
“Mortgage rates remain at record lows and by refinancing, homeowners can generate hundreds of dollars of savings each month and tens of thousands of dollars in savings over the life of the loan,” says McBride.
Low rates are great if you’re looking to get a mortgage or you’re able to refinance an existing mortgage. Those with adjustable-rate mortgages can also benefit from low rates. Demand for mortgages has surged in recent months as low rates have made them more attractive.
Losers include those who are unable to take advantage of low rates, perhaps because they’re underwater on their house or maybe they’ve locked in a fixed-rate mortgage and today’s rates aren’t quite low enough that it makes sense to refinance. In addition, millions of unemployed are unable to gain a direct mortgage benefit from low rates, because they’re unable to show an income.
2. Stock investors
A huge boon for the stock market is the Fed’s policy of open-ended buying of bonds and willingness to keep rates at near zero for as long as it takes for the economy to recover. Low rates are beneficial for stocks, making them look like a more attractive investment in comparison to rates on bonds and fixed income investments such as CDs.
With the Fed keeping rates low and with unprecedented support for the market, investors are likely to keep a floor under stocks. After the initial drop in stocks in the weeks following the emergence of the coronavirus in the U.S., stocks have roared back fiercely and the Standard & Poor’s 500 Index now sits at levels higher than before the crisis – a move that surprises many investors.
3. Savings accounts and CDs
Low interest rates mean that banks will offer low returns on their savings and money market accounts. CD rates have also seen a substantial decline after the Fed lowered rates in early 2020.
CD owners who locked in rates recently will retain those rates for the term of the CD. And those shopping for CDs may be able to still find a relatively attractive deal if they search across the nation’s best rates.
“Unfortunately for savers, lower for longer continues to be the interest rate reality,” says McBride. “Resist the urge to chase yield and take on risk that is ill-suited for the safe portion of your portfolio.”
Savings accounts have largely already felt the brunt of lower rates, as most banks quickly ratcheted rates lower following the Fed’s moves in March. Still, there are a handful of banks that are offering substantially better rates than their peers.
Savers looking to maximize their earnings from interest should turn to these online banks, where rates are typically much better than those offered by traditional banks.
4. Home equity
The cost of a home equity line of credit (HELOC) remains low, since HELOCs adjust relatively quickly to changes in the federal funds rate. HELOCs are typically linked to the prime rate, the interest rate that banks charge their best customers.
Since rates on HELOCs remain low, those with outstanding balances on their HELOC will continue to have low interest expenses. A low rate is also beneficial for those looking to take out a HELOC, and it can be a good time to comparison shop for the best rate.
If you can’t take advantage of the low rates on your HELOC – for example, some HELOCs let you lock in a fixed rate on a portion of your borrowing – then they don’t benefit you, and you might otherwise be paying less. (Here are the pros and cons of a HELOC.)
5. Credit cards
Many variable-rate credit cards change the rate they charge customers based on the prime rate, which is closely related to the federal funds rate. The Fed’s decision to stay lower for longer means that interest on variable-rate cards is likely to remain flat, too.
If you have an outstanding balance on your cards, then a low rate is welcome news. However, it’s important to keep the low rates in perspective, because credit card rates are still among the costliest forms of financing for consumers.
Still, persistently low rates could be a welcome opportunity to find a new credit card with a lower rate.
Low rates on credit cards are largely a non-issue if you’re not running a balance.
6. The U.S. federal government
Debtors welcome low interest rates, because they’ll owe lower payments, and there’s no bigger borrower than the U.S federal government. With the national debt rising to more than $27 trillion, the prospect of low rates remains a spur to refinance outstanding debt at low rates, offering the opportunity to save potentially billions of dollars as the government rolls over its debt.
According to the Congressional Budget Office, the federal government racked up a record deficit of $3.1 trillion this fiscal year, which ended Sept. 30. But low rates mean the borrowing cost of spending more remains manageable, for now. That could be valuable since the government will likely extend emergency stimulus programs as part of its COVID-19 relief plans.
All the liquidity, however, has started to hurt the value of the dollar, with rates on key currencies slipping in the last few months. At some point lower exchange rates may limit how much foreigners want to hold U.S. dollar-denominated debt, at least at such low interest rates.
Of course, the government has benefited for decades from a secular decline in interest rates. While rates might rise cyclically during an economic boom, they’ve been moving steadily lower long term.
With the market expecting ongoing economic weakness due to the coronavirus and millions of Americans collecting unemployment, the Fed is using every tool available to bolster the economy, including trying to ratchet up expectations of future inflation. Rates on financial products remain at record lows, so it may make sense to make your money moves (such as locking in a low-cost mortgage) while you still can.