As a result of increasing fears about the impact the coronavirus may have on the U.S. economy, the Federal Reserve announced an emergency cut to the target range for the federal funds rate of 0.5%. The new target rate is now 1% to 1.25%. This reflects the largest rate decrease in more than a decade and the first emergency cut since 2008.
Most Americans are primarily focused on the health and wellbeing of themselves and their loved ones during this time of uncertainty, and rightfully so. But it’s important not to overlook how the Federal Reserve announcement may impact their financial wellbeing.
Neal Stern, CPA, member of the AICPA’s National CPA Financial Literacy Commission, spoke with AICPA Insights about what the rate cut means for Americans’ finances.
James Schiavone: What does yesterday’s rate cut announcement from the Federal Reserve mean for the average American?
Neal Stern: For many Americans, the recent rate cut by the Fed affects the interest rates they pay on credit cards, adjustable rate mortgages and other loans, as well as the rates earned on savings, because consumer rates are often linked directly or indirectly to the Fed’s rate.
A rate cut is often good news for people who carry credit card balances or adjustable rate mortgages, since their interest charges will typically decline. On the other hand, it’s not such good news for those with savings accounts and investments like money market funds, where interest earnings are likely to decline as banks reduce their rates.
It's important to note that the Fed lowers and raises rate based on how it sees the economy at a given time. For example, rates were increased by 0.25% seven times in 2017–2018, after several years of historically low rates after the financial crisis. 2019 saw three rate decreases of 0.25%.
Americans can take steps to maximize the benefits of lower borrowing rates, protect their savings and investment earnings from further rate cuts, and prepare for the uncertainty of where rates may move over time.
JS: What should people who have outstanding debt in the form of credit cards or loans do in response to the rate cut?
NS: If you’re in the process of paying off a credit card balance, check your statement to see if your card has a variable interest rate, which is likely to decline in response to a Fed rate cut. With lower interest charges, you can pay off your balance more quickly just by maintaining the same payment you made before, since more of your payment will knock down what you owe.
It also may be a good time to shop around for lower rates, since card issuers can compete for your business by passing along the lower rates in balance transfer and other offers. Be sure to understand the terms and any fees involved.
If you have an adjustable rate mortgage or home equity loan, you may see your payments decline due to the rate cut. That’s a great opportunity to use the savings to increase your 401(k) contribution at work, especially if you’re not already taking full advantage of your employer’s matching.
If you plan to stay in your home for more than a few years, it may be worthwhile to check into conversion to a fixed rate mortgage. Interest rates may be initially higher, but you can enjoy the certainty of stable payments without concern about future rate changes, helping you manage your budget and work toward long-term goals.
JS: On the flip side, what are some of the implications for people who have money in a savings account or invested in other assets?
NS: If your bank lowers the interest rate on your savings account, it pays to shop around, including a look at online banks and credit unions that compete for your funds.
You may also want to consider investing some of your money, over what you’ve set aside for emergencies, in a “ladder” arrangement — for example, CD’s that mature in 6, 12, 18 and 24 months. This may get you higher rates than standard savings accounts and helps protect your earnings from future rate cuts. Be aware of any penalties that may apply if you need to withdraw money before the maturity dates.
JS: The Fed attributed this rate decreases to the evolving risks to economic activity due to coronavirus, saying it was done in support of their goals, including price stability. Can you explain the impact of the federal fund rate and the interest rate upon prices?
NS: The Fed makes rate changes as a tool to support the health of the economy, as well as to help manage the risks of inflation. Interest rates are one factor, but not the only ingredient, in driving prices of goods, services and investments.
While lower rates may help price stability by reducing borrowing costs, other factors like supply disruptions and travel restrictions can have an impact as well. Especially in a time of elevated uncertainty, it pays to keep your long-term goals and risk tolerance in mind when making financial decisions.
A qualified financial adviser, such as a CPA financial planner, can help you develop a long-term plan that fits your situation.
JS: Over the past week or so, there have been big swings in the market as investors react to evolving news on the coronavirus and the rate cut announcement. Should investors look at these swings as an opportunity to make money buying and selling stocks quickly?
NS: It's difficult to predict how the market will react to the rate cut over the coming weeks, or other developments that may come into play. While rate cuts have stimulated economic activity and markets in the past, we're still living with the same causes for concern that triggered recent volatility like potential supply shortages and disruptions to some businesses and industries.
Trying to predict market timing or substituting headline driven emotions for a solid long-term plan based on your goals and risk tolerance can put your financial future in jeopardy.