What the Fed Rate Cut Means for the Average American

Credit card companies have the opportunity to lower interest rates, but that usually happens slowly as card companies are reluctant to lower their margins quickly, Sonnier said.

Sonnier noted that many people think that the Fed controls all interest rates, but in fact it controls only the federal funds rate and the rate it charges other banks to borrow from the Fed. The Fed funds rate is the central bank’s main tool to influence other short-term rates.

This means that short-term rates that influence the rates that savers and investors receive on savings accounts, money market accounts, CDs, T-Bills and floating-rate bonds will probably decrease in lock step with the fed funds rate.

Although this will hurt retirees who rely on income from short-term instruments, Sonnier said, it will likely not have a major effect on longer-term interest rates that affect fixed income investors in most bond portfolios, mutual funds and ETFs.

Why? The lowering of short-term rates is expected to create a return to a more traditional upward sloping yield curve with short-term rates falling, but longer-term rates remaining mostly unchanged.

“The longer-term rates reflect the outlook of the markets that growth in the economy is likely to stall or fall slightly in the one- to five-year horizon,” she said.

Sonnier noted that the rate cut would pinch savers and retirees, lowering rates they receive on savings accounts, money market accounts and CDs. In addition, banks will likely see a decline in earnings and their stock prices as their margins narrow with declining rates.

Even as short-term rates go lower, longer-term rates are probably anchored to a tight range for the foreseeable future, meaning mortgage rates are unlikely to fall much, Sonnier said.

“This will not help potential homebuyers to afford homes in today’s tight market,” she said. “High home prices and limited inventory, not mortgage rates, are more to blame for homebuyers’ difficulties in purchasing homes.”

Moreover, if the Fed’s rate cuts contribute to a continuation of the economic expansion, those conditions are likely to get even worse, she said.

But those ready to buy a home now do not need to rush to lock in rates as they are not likely to rise anytime soon, according to Sonnier. Indeed, it could be more advantageous to have another look at adjustable-rate mortgages, which have been out of favor for some time.

“A mortgage with an initial fixed period followed by an adjustable period, like a 5/1 ARM, will typically have a very low initial or ‘teaser rate,’ which then converts to an adjustable rate setting off of a short-term index like the T-Bill rate,” she said.

“These can be a good alternative as long as you manage the risk of the rate conversion by carefully planning to convert to a fixed-rate mortgage at some time before rates start rising again or if you plan on only being in the home less than five years anyway.”

In the near term, falling rates definitely favor the borrower over the investor, Sonnier said.  Borrowers may find good opportunities to refinance older debt at higher rates or lock in fixed rate financing to roll over older adjustable-rate debt, including student loan debt.

For fixed income investors, short-term rates are still a relatively attractive parking place until the longer-term rates return to a more normal level — though that could be years ahead.

“Although investors have been pouring billions of dollars each week into bond funds and fixed income investments, history generally shows that falling rates are a good thing for the stock market,” she said. “The stock markets generally have double-digit gains in the early years of an easing cycle by the Fed.”

— Check out 10 Scariest Retirement Statistics: 2019 on ThinkAdvisor.