What Rate Cut Means to the 99% Americans
This past Wednesday, the Federal Reserve announced its decision to reduce federal funds rate by 25 basis points from 2.50% to 2.25%. While the “rate cut” is highly anticipated, this action is monumental in that it is the first rate cut since the 2008 Great Recession or financial crisis, when the Federal Reserve famously dropped the rate to effectively zero. See chart below.
What does the “Cut” Mean?
So what does this all mean? Will this evolve into a “Great Rate Cut”?
For the business world, this news is interpreted as generally positive. If you’ve been following the news recently in any way, this shouldn’t come as a surprise. With all of the Trump-Xi trade skirmishes and geopolitical news that surfaces everyday, a rate cut incentivizes businesses to invest and hire more.
This is because when rates are lower, business borrowing costs are lower. It’s like giving all the businesses across the country a “Zero Intro APR Until 2020” credit card. What do you do with all that cheaper money? You spend it. And when business invest, it’s supposed to help the economy and give it the boost it needs.
For you — the individual consumer — the impact of the macroeconomic, geopolitical risks seem rather remote. But here’s what an average American consumers should do to maximize their opportunities, avoid problems, or in general make their financial lives happier.
1. Consider Your Next Home Purchase
Since November 2018, as the Fed ceased to raise rates, the average rate on a 30-year mortgage has fallen precipitously from 5 percent to 3.75 percent. If we examine the mortgage rates history for the last 50 years, the average 30-year rate has never dipped below 3.3 percent. In other words, we are likely near the bottom in where the mortgage rates will go, and the only direction it could likely go is — up.
Which means, if you have the savings, you might want to look into benefiting from the lower mortgage rate today and investing in your next home. The case for home purchase is strengthened given that most economists today believe that the overall U.S. economy remain healthy and job prospects remain robust. Time to think for the longer term.
If you haven’t had saved toward your first home downpayment, look into one of the online savings accounts. More on this later.
2. To Motorize, or Not to Motorize
Historically, the rates on car loans does not always move in line with the Fed’s rate decisions. In 2016, the rates on car loans fell even though Fed raised rates. Most economists believe that the rate cut decision announced Wednesday will unlikely change consumer purchasing behaviors, which means that the expectation by car loan providers will be softened, reducing the likelihood for any change in car rates.
So, if you’re considering your next car purchase, keep doing what you’re doing.
3. Control Your Credit Card Spending
The average interest rate on your credit card has risen by many percentage points over the past few years as Fed raised rates. It is now nearly 18 percent. More importantly, it has not fallen recently as it did for your mortgage rates or the your savings account interest rates.
So while the Fed rate cut gives all the businesses across the country a “Zero Intro APR” credit card. Remember that it does NOT apply for you. It’s important to continue to keep a disciplined spending habit, so that you can save more and avoid the vicious cycle of the 18 percent credit card debt that keeps racking up without you noticing.
4. Open a High Interest Bank Account (HIBA)
“Wait, what? My bank account pays me and interest?” You ask. “How did I not know that?” As it turns out, there is a solid reason for you to feel surprised. Today, almost two-fifths of the working age population are millennials, defined as those of us who were born between early 1980s and early 2000s. The oldest cohort of millennials was just entering the workforce, thinking seriously about saving for their next home downpayment, when the 2008 financial crisis hit. And guess what, from the time they remember, the interest rate offered by their bank accounts have been approximately zero.
Not just for millennials, so much of what we believe about our banks and our bank accounts are shaped by this past 10 years of “zero-interest decade”. So much that we have already subconsciously forgotten that banks should be paying us more than the 0.01% interest we are receiving today across Chase, Bank of America and Wells Fargo.
Don’t forget that the current U.S. inflation rate is above 2.8% based on Federal Reserve Bank of Dallas’ “trimmed mean ” inflation gauge. So your cash is sitting at one of these big banks losing money to inflation while banks continue to hit their record earnings — $237 billion of record earnings in 2018 (up 44% from the year prior).
If the Fed’s Wednesday rate cut is remotely successful in its intent to boost the U.S. economy, expect inflation to further rise. The best prevention? Open a High Interest Bank Account (HIBA), offered by one of the the mobile or online banks.
5. Be Optimistically Cautious About Getting into Stocks
Economists believe that Wednesday’s Fed rate cut signals the start of a longer-term easing cycle, which means that there could be more rate cuts on the horizon. As discussed above, further rate cuts would be considered positive boosts for the market, and stock prices will likely continue to climb higher.
That said, stock market goes up and down and the average American “retail” investors have very little edge against the Wall Street heavy-weight traders who have better access to corporate C-suites, and a plethora of research resources (not to mention better computing and trading infrastructure) to give them an “unfair” advantage.
Some would say that the geopolitical and macroeconomic risks today remains high. The global growth remains slow. All this could mean that the stock market could be peaking with the Wednesday Fed rate cut announcement, with the market interpreting that the Fed also think that the U.S. economy has downside risk. We can’t predict the market, but we know that it isn’t a wise decision for you to invest in something that you’re not 100% sure of — the very definition of gambling.
Thus, our general advice to the average American is this: Choose to invest only when you see an opportunity that you know more about than the average trader on Wall Street. Before you invest, keep your cash at a liquid, FDIC-insured, High-Interest Bank Account (HIBA) like Beam. After you invest, if the market crashes, a HIBA is where you can fall back on.
