It’s not over yet.
Just two months after slashing interest rates by a full percentage point, the Federal Reserve Board will step up to the plate again on Tuesday because the economy is starting to look like a washed-up pitcher, experts say. The only question is whether policymakers will hit a double (cut rates by one-half of a percentage point, or 50 basis points) or a triple (75 basis points).
Either way, rates on everything from new car loans to variable-rate credit cards should fall even further in the coming months than they have already. The Fed controls two rates directly — the federal funds rate and the discount rate. When it slashes those rates, as members of the Fed’s policy-setting Federal Open Market Committee are expected to do March 20, the prime rate falls and so do the rates on financial products tied to it.
“Everybody out there is expecting 50 basis points, with a small chance at 75,” says Duane Homan, vice president of secondary marketing at home builder Centex Corp.’s mortgage division. After next week, he adds, the Fed will probably have to cut rates even further, though he’s not sure when and by how much.
“The chance of an inter-meeting move, especially if stocks keep going down, is pretty good. It’s going to be continually worsening economic numbers coming out,” that will force their hand, Homan says. “They’re not targeting the equity markets, but they may feel compelled to move to boost consumer confidence, which is going to get killed with all of these stock market losses.”
Ah yes, the stock market. Once a source of fascination that was thought to have an almost mythical power to enrich even the lowliest American, it’s now an object of disgust. The Nasdaq’s wrenching decline (and the smaller declines of the other major indexes) has vaporized billions upon billions of investment wealth. In part because of that portfolio deflation, consumer confidence and, to a lesser degree, spending, has fallen. At the same time, job growth has slowed and manufacturing activity has continued to contract.
So a cut of 75 basis points — which would bring the key federal funds rate down to 4.75 percent from its current 5.5 percent level — isn’t out of the question.
On the other hand, sales of big-ticket items such as houses and cars started the year off fairly strong. Retail sales of other goods dipped slightly in February, but the government revised its January figures sharply higher. That suggests consumers haven’t yet put their wallets away and that the Fed may not be inclined to swing for the bleachers.
Regardless of the exact magnitude of next week’s cut, it will help indebted consumers improve their financial positions, as long as they’re willing to stop spending beyond their means. Lower interest rates on variable-rate credit cards and home equity lines of credit lower the cost of carrying outstanding balances, as well as minimum monthly payments. That frees up money borrowers can use to either build up their savings or pay down their debts. One caveat: credit card companies and home equity lenders adjust their rates either monthly or quarterly, so any financial impact from a Fed cut could be weeks away.
Other types of consumers stand to benefit, too. Car shoppers will see lower loan rates over the next several weeks, for instance. But those who can wait for a new set of wheels may want to do so. Fed officials will probably cut rates yet again at one or both of their next meetings, which are scheduled for May 15 and June 26 and 27. That means even cheaper financing should be available this summer.
As for house hunters, loans probably won’t get much cheaper. Mortgage rates aren’t tied to prime; they fall in anticipation of Fed rate cuts rather than wait until the cuts happen. Most of the decline in home loan rates already took place in late November and December 2000 and long-term fixed rates already reflect the potential for another rate cut or two. For them to fall further, the economic outlook would have to deteriorate even more than it has already.
“We think a half a point is already built into the market,” says Donnell Smith, executive vice president at Market Street Mortgage Corp. in Clearwater, Fla. “If it’s anything less than that, I think the market’s going to react negatively to that. If it’s more than that, I think the market will react positively.”
Consumers should have plenty to react positively to, though, as low rates of all kinds should be here to stay for most of 2001.
— Posted: March 16, 2001