For Wall Street and Main Street alike, the 12th time isn't a charm.
Federal Open Market Committee is 100% certain to cut interest rates by at least 25 basis points Wednesday, if the fed funds futures are right. But if you think this cut will mean much for real-world things like your mortgage, your job security or even your stock portfolio, think again.
When the Fed cuts the federal funds rate -- the 12th cut since the start of 2001 -- it's actually cutting the interest rate that banks charge each other for an overnight loan, which gives the Fed a great deal of power over short-term interest rates.
On Jan. 2, 2001 the fed funds rate stood at 6.5%, while the one-year bond had a yield of 5.16%. A dozen rate cuts later, the fed funds rate stands at 1.5%, while the one-year yields 1.41%.
Here are the five ways the latest cut will affect consumers' wallets. Unfortunately, they don't add up to much:
1. The Fed Doesn't Lower Fixed-Mortgage Rates ...
One consumer misconception is that the Fed cuts directly change the rate on fixed-rate mortgages. While it is true that the precipitous drop in the funds rate coincided with a similar drop in long-term mortgage rates, the outlook for the economy plays a major role.
"There's no direct correlation. Fixed rate mortgages, like the 30-year, are priced off the 10-year Treasury," said Doug Duncan, chief economist with the Mortgage Bankers Association of America.
In fact, given the fact that interest rates are low on both the short and intermediate ends of the bond spectrum, a Fed cut could push rates higher. It all depends on the expectations priced into the bond market. If traders think a recovery is at hand, Duncan said they could start moving into intermediate bonds like the 10-year note.
"If investors believe the Fed cut is the last straw needed to boost the economy, they could go further out on the yield curve," he said. "That would actually raise
And for those hoping for an even better mortgage-refinancing opportunity after number 12, many experts say rates can't get any lower: On PIMCO's Web site, bond guru Bill Gross says mortgage rates will not follow fed funds "basis points for basis point" lower: "There will never be much less than a 5% 30-year GNMA, Freddie Mac, or FNMA mortgage issued in size no matter what Greenspan does" because it creates too much risk for mortgage buyers.
2. ...but It Will Make ARMs a Bit Cheaper
Unlike fixed-rate mortgages, a Fed cut will affect adjustable-rate mortgages, also known as ARMs. The rate on an ARM is actually pegged to short-term interest rates, like the one-year Treasury or the 11th District Cost of Funds Index, with a premium added in to ensure a bank's profit margin. When the Fed cuts rates, ARMs tend to fall.
But with short-term interest rates already at such lows, banks may not be so willing to drop ARM rates by much. "Once you get below a certain point, there's not that much of a gap between the rate on a one-year and what you get on an ARM," Duncan said. "You're not going to see a huge reaction. It's certainly not going to hurt consumers, but it won't have a major impact this time."
3. Some Loan Rates Will Be Lower, but Not By Much
By influencing short-term rates, the Fed has an indirect effect on the prime rate, which is used to set loan rates for a variety of short-term consumer loans. But when rates fall, banks don't immediately lower their rates, stubbornly clinging to higher profit margins for as long as they can. This means any benefit you see could be slight and slow to materialize.
Consider: Even though the fed funds rate has dropped 500 basis points in slightly under two years, the rate on a 60-month new car loan has dropped from 9.5% to about 6.5% -- a move of 300 basis points. Expect the fed cut to drop rates a bit lower for the rates on auto loans and credit cards, which use the prime rate, plus a hefty premium, to determine your annual percentage rate.
But given that loans on autos and the like have plunged to keep consumers free to pile on debt with abandon, rates won't go any lower unless they start giving you money upfront.
4. CD Rates May Keep Falling
In the middle of 2000, when the bubble was deflating but before the Fed began cutting rates, a six-month certificate of deposit had a rate in the 7% range, according to Federal Reserve statistics. Today, the national average is well under 2%, which is one reason why the personal savings rate (the amount you save in relation to your personal income) fell from 2.8% in 2000 to 2.3% last year.
Unfortunately, you'll see the effects of a Fed cut almost immediately. While banks are slow to lower the rates they charge you, they're very quick about cutting the rates they'll pay you for saving.
5. Stocks Aren't Going to the Moon
Back in January 2001, the Fed's Happy New Year surprise rate cut provided the market with a shock rally. This battered market may be beyond shock therapy, and a cut of 25 basis points is widely expected and priced in at this point. OK, if the Fed opts for a 50 basis point cut Wednesday, which Fed watchers expect in total by the end of the year, that'll give the market a shock. But that move may also signal that the economy is in more dire straits that many investors already realize.
Either way, the rate cut alone can't provide the year-end Christmas present everyone really craves: A quarterly portfolio statement that shows the market and the economy have turned for good.