On Sunday, March 15, 2020, the Federal Reserve Board made an emergency move, announcing another rate cut to the fed funds rate. As with the previous rate cut, this one comes in response to the unprecedented events and impact brought about by the global spread of the coronavirus. The virus’s proliferation has been wreaking havoc on economies across the world, sending markets into a tailspin not seen since the financial crisis of 2008.
The Fed announced that the emergency reduction now sets the target fed funds rate at 0% to 0.25%, down from the previous target range of 1% to 1.25%. What’s more, the Fed also cut the rate of emergency lending at the discount window for banks down to 0.25% and extended the term of loans to 90 days. The next FOMC meeting was planned to be held over the course of two days on March 17-18, 2020, but Sunday’s emergency move preempted it and it has now been canceled.
In the last FOMC meeting on March 3, 2020, the fed funds rate had been cut from a target range of 1.50% to 1.75%, down to 1% to 1.25%. Before that, the FOMC meetings held on January 29, 2020 and December 11, 2019 had left the target range as 1.50% to 1.75%. This was consistent with Fed policy at the time, but the dramatic effects of the spread of the coronavirus necessitated a sharp shift in policy. The previous fed funds rate reduction occurred on October 30, 2019, when the Federal Open Market Committee (FOMC) announced a 0.25% cut in the prime interest rate, lowering the federal funds rate to a range between 1.5% and 1.75%, which lasted until the FOMC meeting in early March.
The cuts in 2019 were the first set of rate cuts since 2008 and, with the Fed’s two emergency reductions in one month, the effective fed funds rate is down to levels not seen since at least 2018. But what does all this mean for Wall Street — and Main Street? And what does this mean for you as an individual and an entrepreneur?
What to Know About Interest Rates
The interest rate that the Federal Reserve Bank controls is the federal funds rate. The federal funds rate is the rate that banks charge one another for overnight loans. The Federal Reserve Board sets a target rate for these loans, but it cannot force banks to charge this rate. So when you hear that ‘the Fed’ cut or raised ‘the interest rate,’ it’s the Fed funds rate they’re referring to.
The fed funds rate is not the same thing as the prime interest rate, but the two rates typically move in the same direction. So, a decrease in the fed funds rate usually precipitates a decrease in the prime rate and vice versa. The prime rate is the interest rate determined by banks. Again, the Federal Reserve Board cannot dictate this rate, but their actions often influence it.
The FOMC consists of the seven members of the Federal Reserve Board of Governors and five of the 12 Federal Reserve Bank presidents. It is the Federal Reserve System’s monetary policymaking body.
How a Rate Change Could Affect You
When rates fall this generally results in banks charging less when their customers borrow money. Whether it’s a small business loan, a mortgage or a student loan, a lower fed funds rate often leads to lower rates on loans.
Credit card rates are expected to fall, too. If you check your credit card statement, you may see that your rate is variable, and expressed as a number added to prime, such as “Prime + 14.99%.” In this case, the interest rate you will be charged on your credit card balance will be 16.99% if the prime rate is 2%, but 17.99% if the prime rate is 3%.
Additionally, savings account rates, especially those on high-yield savings accounts, also typically fall, as they have in the past after similar rate cuts.
What Happens Next?
The global spread and impact of the coronavirus has pushed interest rates down to essentially zero, which is where they were for years in the wake of the financial crisis and Great Recession. While this is great in terms of getting access to capital affordably, which is reassuring, cutting rates isn’t a solution in itself. As one investor noted, rate cuts won’t reopen factories or nurse sick people back to health.
It is difficult to speculate about interest rates in general, but it has become even tougher now as the Fed reacts to an ongoing, developing situation. With American economic growth described as “moderate” before the coronavirus threat emerged, future rate changes will probably still be reductions, not increases. A fed funds rate increase would only serve to tighten credit, make money more expensive and, therefore, slow down growth, adding further stress to the already destabilized global economy. Jerome Powell has proven very cautious and steady with policy, concerned mainly with hitting inflation objectives as much as, if not more than, business activity targets. However, the first emergency rate reductions since 2008 signifies that cautious plans could be disrupted.
It’s All Relative
The target range for the fed funds rate, as of March 15, 2020, has now changed to 0%-0.25%. Historically, this is extremely low. The average rate from 1971 to 2019 was 5.66%, and the highest rate ever was 20% in March 1980. At this point in time, it was not unusual to see home mortgages with interest rates of 18%-20%. This sounds horrifying to those with 3% mortgages today, but the effect was to depress home prices so that people could still afford their mortgages. Once the rate started to decline, the refinancing boom was born as homeowners fled their high-rate loans.
The Future Outlook for Rates
With the target feds fund rate at 0% to 0.25%, the Fed doesn’t have much, if any room, to maneuver in terms of interest rate cuts. The effect of these rate cuts on the stock market has not helped, but as they take hold, small businesses could respond to them better than markets. With rates at essentially zero, money is cheaper to borrow, which is good news for small businesses, especially since working capital and cash flow are typically their biggest challenges. It’s difficult to speculate about future actions, but the fed funds rate is likely to stay where it is for some time, likely covering the duration of the coronavirus’s impact and the recovery from it.
The FOMC meets eight times per year to decide whether to adjust the interest rate, so we won’t have to wait long to find out what happens next.