The Fed shocked Wall Street Tuesday (December 16) afternoon when it announced a .75 point cut in the Fed funds rate bringing the rate the government charges lenders to a record low of .25 per cent. The discount rate was cut to .5 per cent. This means that it should be cheaper than ever for consumers and businesses to borrow money for spending, though analysts expect a bounce higher in mortgage rates.

Most analysts had predicted a half-point cut from the Fed while some more conservatively expected a ¼-point cut or no cut at all. No one really expected the Fed would be so aggressive. However, Fed Chief Ben Bernanke stated that with inflation under control, the Central Bank is empowered to do whatever is in its control to encourage borrowing and economic expansion. Bernanke indicated that he expected rates to stay low for sometime until there is no question the economy is stabilized and heading back to where it belongs.

Many financial and consumer markets are impacted by today’s move. The Fed funds rate had already been a very low one per cent and many bears still believe consumers are too scared to borrow and spend in the current climate. However, already low credit card and personal loan rates should now be at a point where it is hard for middle class Americans to avoid the temptation to buy now and pay later. Many excellent credit borrowers are seeing credit card rates and other revolving loan rates as low as 5-6 per cent.

Mortgages have been as cheap as ever this week. According to bankrate.com, the current national average for mortgage rates is 5.64 per cent. In some parts of the country, consumers are seeing rates posted as low as 4.875 per cent with discounts and other fees applicable. Some analysts believe the cut in the funds rate may actually see mortgage rates go back up a bit. Mortgage rates tend to operate more as speculative markets do with trends based more on expectation than actual events, meaning after a rate cut, mortgage rates may go back up. Mortgage-backed security investments have much to do with mortgage rates. Home equity loans and other secured loans are more likely to stay in synch with rate moves and dip lower.

The hope of the Fed is that consumers will feel more comfortable opening up their wallets and that businesses will be more comfortable expanding and maintaining jobs that might otherwise be cut. Rate cuts alone cannot fix everything currently wrong with the US economy, but the Fed appealed more to investor and American interest with the conviction of its move and its willingness to take the steps necessary to help turn things around.

The dollar suffered more after the rate cut. Most currency speculators had made bets on dollar movement expecting a .25-.5 rate cut. The .75 point cut sent the dollar flailing against the likes of the yen and the Euro. Surprisingly strong rate cuts are negative for a currency becomes it makes carrying the currency less beneficial. Currencies that have higher interest yields are more enticing for conservative currency speculators because even if the currency moves counter to their investment, there is still a chance to earn some interesting against a lower rate currency.

Consumers and businesses have been reluctant to take action after many of the other government interventions late this year. However, at some point, people are going to realize that loan rates may never be so low again, and a great opportunity lies before them.

Market Recap

The Dow dropped a modest 61 points Monday as investors pondered the prospects for an auto bailout and speculated about Tuesday’s rate cut decision from the Fed. The dollar continues to fall against the major currencies, especially the yen and European currencies. Gas prices ended an 86-day stretch of gains. The Dow picked up 359 points and the NASDAQ and S&P were up 81 and 44 Monday. After modest gains early, the markets shot higher following the shocking news that the Fed cut the fund rate to ¼ point with a ¾ point. This is a new record for the funds rate and should make already low borrowing costs even lower. The dollar pulled back sharply on the news.

Neil Kokemuller
Tuesday, December 16, 2008
9:00 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

Please note: The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments. Actions taken on the basis of the information shared is at the sole risk and discretion of the individual. Currency investment poses significant risk of loss.