The Fed, specifically, the Federal Open Market Committee (FOMC), is not having their monthly meeting this August but many of the members are gathering this week in Jackson Hole, Wyoming with a bunch of financial big shots for their annual summer conference. The investment world will be tuning in to get any hints on what they plan to do with interest rates when they meet in September. So, I thought it would be a good time to review what happens when the Federal Reserve changes interest rates.
When the FOMC changes interest rates, they aren’t changing every rate out there. They are only changing the Federal Funds Rate (FFR). This is the rate that banks charge each other for overnight loans. Modifying this rate is one of the Fed’s tools that they use to maintain a healthy economy. They lower it if they feel the economy is slowing and raise it if the economy is heating up too quickly.
For example, if unemployment is trending up, the Fed would be more inclined to lower rates. If consumer prices (inflation) are going up at a higher rate than expected, they would consider raising rates to slow the increase.
Although you probably have never heard of the Fed Funds Rate, it does influence many of the interest rates that you are familiar with and interact with every day. The FFR is the base that the cost of money in the banking system is built upon. In fact, the prime rate, which almost all bank loans are based off of, is derived from the FFR and is typically 3% higher than the FFR.
Now, let’s take a look at the table below that shows what is expected with various rates and other economic factors when the FOMC changes the Fed Funds rate:
| When FOMC raises the FFR, plan on: | When FOMC lowers the FFR, plan on: | |
| Mortgage rates | Higher | Lower |
| Car loan rates | Higher | Lower |
| CD rates | Higher | Lower |
| Money market rates | Higher | Lower |
| Credit card rates | Higher | Lower |
| Business profits | Lower | Higher |
| Stock market | Lower | Higher |
| Consumer spending | Lower | Higher |
| Home sales | Lower | Higher |
These expected changes don’t happen overnight. It takes time for the Fed’s actions to trickle down to other rates and markets. For instance, if the Fed raises the FFR, the stock market might not go down until rates are high enough in other investments, such as bonds or CDs, to justify the shift from stocks to those other investment options.
This should give you a better understanding of what is happening when you hear that the Fed is changing interest rates.
Please comment or send an email if you have any questions.
Joe Baker, CFP®
Baker Asset Management, LLC
joebaker@bakerassetmanagement.com
