The Federal Reserve left its target for the benchmark federal funds rate unchanged today. The decision means that rates for some types of consumer debt — such as variable-rate credit cards and home equity lines of credit — will stay where they are.
The federal funds rate, which banks charge one another for overnight loans, will remain at 2 percent. That means that the prime rate will stay at 5 percent. Home equity lines of credit and variable-rate credit cards are linked to the prime rate, so their rates won’t change. Rates for mortgages and other types of consumer debt, such as auto loans, are set by markets and move independently of the Fed.
Rates on certificates of deposits tend to move in the same direction as the federal funds rate, but not immediately. The Fed has a stronger influence on shorter-term CDs than on longer-term CDs.
This meeting of the Fed’s rate-setting body was unusual, because so much uncertainty surrounded it. Usually the central bank telegraphs its rate decisions to avoid surprising investors. The Fed held the federal funds rate steady this time, but it had seemed equally as likely that the central bank would cut it by a quarter of a percentage point or half a percentage point. The Chicago futures market pegged the odds of each course of action at roughly 1-in-3.
“Who knows what the Fed is going to do today? We’ve never been in a financial market mess like this,” David Seider, chief economist for the National Association of Home Builders, said a few hours before the central bank’s announcement. His sentiment was shared by economists and investors everywhere.
Explaining its decision, the Fed’s rate-setting Open Market Committee said that inflation is high and is expected to moderate over the coming months. “Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters,” the Fed said. “Over time, the substantial easing of monetary policy, combined with the ongoing measures to foster market liquidity, should help to promote moderate economic growth.”
It was a way of saying that the Fed will keep money flowing through the financial system, but not by printing more of it. The central bank concluded its explanation by saying that the “downside risks to growth and the upside risks to inflation are both of significant concern.”
Before the Fed’s announcement, economists were saying that it didn’t make much difference what the Fed did — whether it cut rates this time, or whether it laid the groundwork for a rate reduction later. Seiders leaned toward hoping that the central bank would cut rates today, preferably by half a percentage point.
Rate cuts are designed to encourage people and businesses to save less, borrow more and spend. Whatever the Fed does, there’s always a trade-off. In the case of lower interest rates, the trade-off is higher prices. It appears likely that the Fed will cut rates sometime before year’s end.
“I think the inflation concerns are being back-burnered, and they damned better be,” Seiders says, and the Fed should “focus on growth and stability of financial markets.”
William Hummer, chief economist for Wayne Hummer Investments in Chicago, preferred the Fed to keep rates unchanged and issue a strong statement to reassure investors. Hummer is in his 80s, and the market turmoil of the last couple of weeks doesn’t frighten him. “I think I’ve seen this movie before,” he says. He especially recalls the stock market crash of October 1987, which was deeper and broader.
“This is a very localized sell-off,” Hummer says. “It mainly concerns big financial institutions.” A drop in the federal funds rate, he says, “is not too meaningful.”
The federal funds rate is the target interest rate for banks borrowing reserves among themselves. The discount rate is the interest rate that the Fed charges banks to borrow reserves from the Federal Reserve. The Fed wants to be the lender of last resort: It wants banks to borrow from one another at the federal funds rate before borrowing from the Federal Reserve at the higher discount rate.