The Federal Reserve is the latest government entity to take action against the spreading coronavirus and by extension, the U.S. economy, slashing benchmark interest rates from between 1.5%—1.75% down to 1.0%—1.25%.
The Federal Reserve issued a statement with its rate cut release, tying the threat of the now burgeoning coronavirus with the fortunes of the U.S. economy.
“The fundamentals of the U.S. economy remain strong,” a Federal Reserve statement said. “However, the coronavirus poses evolving risks to economic activity. We’re closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.”
The vote to lower rates was unanimous, fueling more consternation among consumers that the virus is gaining steam and that the U.S. government continues to take drastic action to deal with a potential pandemic.
Impact on Consumers
Aside from continuing health concerns among the U.S. population, what will the Fed’s rate cut mean to consumers in their pocketbooks?
According to financial experts, the Federal Reserve rarely steps out of its comfort zone to curb rates so abruptly – and that’s a telling sign for financial consumers.
“Rate moves don't happen outside of regularly scheduled Fed policy meetings very often,” said Matt Schulz, a credit industry analyst at CompareCards.com. “They did so during the Global Economic Crisis, but this is the first time since then. It speaks to how serious an impact the Fed thinks the coronavirus might have on the economy.”
The new cut is the biggest rate decrease for the Fed since 2008, and credit cardholders should expect to see their APRs drop by a half of a percentage point within the next billing cycle or two, Schulz said. “The decrease won't happen overnight, but it will happen for the vast majority of cardholders,” he added.
For kitchen table economic impact, what are the further “pros and cons” on the Fed’s sudden move to slash rates? Here’s a thumbnail sketch on both sides of the rate cut equation.
Upsides of a Half-Point Federal Reserve Tax Cut
Lower Borrowing Costs
An immediate benefit to households from the Fed’s rate cut is lower borrowing costs on big-ticket items like mortgages and autos. “There is a caveat - consumers most likely to benefit from the rate cuts are homeowners and borrowers with solid credit profiles,” said Peter Donisanu, chief financial strategist at Franklin Madison Advisors, Inc., in Pittsburgh. “To this point, average credit card rates have gone up over the past year even as the Fed has taken a more accommodative stance over the same period of time.”
A Chance to Get Better Credit Card Deals
Tuesday’s emergency interest rate cut was welcome news. But even if rates are lowered by half a percentage point, credit card debt is still some of the most expensive debt around, said Sara Rathner, credit cards expert at NerdWallet, in Richmond, Va.
“One of the best things consumers can do to get serious about paying down their debt is to comparison shop for better card deals,” Rathner noted. “If you have a good-to-excellent credit score, you may qualify for a balance transfer credit card, which gives you a year or more to pay down a balance interest-free.”
“If you can eliminate your debt before the 0% APR promotion ends, you stand to save hundreds or even thousands of dollars in interest,” she noted.
A Cheaper Borrowing Rate Can Boost the Economy
“Businesses are able to continue borrowing to facilitate business which leads to a trickle effect in the economy, stimulating or allowing businesses to continue growing,” said Chris McDermott, a real estate broker and a principal at Jax Nurses Buy Houses, a real estate investment company in Jacksonville, Fla.
Downsides of a Half-Point Federal Reserve Tax Cut
Lower Bank Savings Rates
When the Fed cuts its benchmark lending rate, banks usually follow suit – and that’s not good news for bank savers.
“If last year’s pattern continues – and there is every reason to believe it will — the Federal Reserve’s emergency rate cut will be followed by a cut to savings account interest rates, especially at online banks, where rates tend to be higher and more reactive to changes in the benchmark rate,” said Arielle O’Shea, a banking specialist at NerdWallet.
O’Shea advises bank savers to start looking for better rates online, and the sooner the better.
“Online banks will continue to offer the most competitive rates, head and shoulders above what’s available at brick and mortar branches,” she said. “Savers should continue to shop around, looking at both online savings accounts and cash management accounts — a very similar product often offered by investment firms and robo-advisers — to find the best rate.”
It May Lead to Higher Consumer Debt
The Federal Reserve cutting rates in a time of high employment can lead to consumers spending more with a false sense of reality. “Unfortunately, when the economy does slow down, it can lead to increased default rates if those unemployed are unable to make payments,” McDermott said.
More Risk for Fixed-Income Americans
Savers are going to take a hit from today’s emergency rate cut, said Donisanu. “What’s more, lower interest rates are likely to further incentivize households to reach for yield, particularly those living on a fixed income,” he noted. “Such a development would be disconcerting, particularly at a time when the economic outlook is likely to deteriorate and market volatility is on the rise.”
The Fed Has Limited Options Going Forward
The Wall Street rumor mill notes that the Federal Reserve was going to cut interest rates by a quarter-point later this month anyway. In that scenario, a half-percent rate cut isn’t as dramatic.
Even so, yesterday’s interest-rate action leaves the Federal Reserve with limited options going forward – even if the coronavirus threat expands significantly.
"Now that the benchmark federal funds rate target is lower, it must be noted the Fed’s most reliable ammunition, meaning lower rates, are dwindling,” said Mark Hamrick, senior economic analyst at Bankrate.com. “The other challenge involves how the Fed may take back the rate cuts once the outbreak and economic damage are behind us."
Additionally, lower interest rates “do little” to make consumers and businesses feel substantially more confident about the future when a health crisis is spreading around the world, Hamrick noted.
“It also cannot address the hobbled supply chains, including manufacturing capability in China and South Korea,” he said. “Still, the Fed is doing what it can to try to keep the economy out of recession."