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Fed Funds Cut Again To A Historical Low! What does this mean? Great Talking Points!

In our commitment to be the “Go To” source for market information, we felt that this important information could not wait until the end of the week.  As you may be aware,  the Fed Committee created today a new target range for its Fed Fund rate so that it will hover between an unprecedented 0-.25 percent (which means the target decreased .75-1.00)! That dramatically lowers the Fed’s targeted rate, called the federal funds rate, which had stood at 1 percent.

The bold move surprised economists, most of whom were predicting the Fed would cut the funds rate in half to 0.50 percent. The funds rate is the interest banks charge each other on overnight loans (and is a daily moving target).  With the Fed’s key rate dropping to rock-bottom levels, the central bank is moving into uncharted territory.  The cut of .75-1.00, (to a new target rate of 0-.25), makes this a historical move and the lowest Fed Fund Rate- ever.  Our phones (and yours) will start ringing, so what do these numbers mean for the consumer?

First a little history (ok, don’t glaze over- it is important that you know how to explain this to your clients who ask- and it is also great conversation to throw out at your next Christmas party ).       The Fed Funds Rate is the rate banks charge each other to borrow money or the “wholesale” cost to borrow money.  The rate is short term & is often referred to as the “overnight lending rate.” It changes daily and is a sensitive indicator of general interest rate trends. The Federal funds rate is one of the two interest rates controlled by the Fed (the other is the Discount Rate- what banks borrow overnight from the Fed).  It is important to note also here that the Discount Rate was decreased to .50 today (another unprecedented and historical decrease of .75)- which again is the lowest ever in the history of our economy.  

So, when you hear that Fed Chairman Bernanke has “lowered (or raised) interest rates”, they’re talking about the Federal Funds Rate.  The Federal Open Market Committee (FOMC) meets eight times per year wherin they set a target for the federal fund rates (although they can – and have- changed it outside the scheduled meetings)   Other rates, including the Prime Rate (typically @ 3% higher than Fed Fund), derive from this base rate.

The Fed’s most important role is to fight inflation, deflation, recession & keep the economy on track.  How do they do this?  They do this by influencing the cost to borrow money with the Fed Funds Rate.  This historical move is to attempt to loosen credit lines so that businesses and individuals can obtain short-term credit again and so that more people will be prone to purchase.   This should simulate more inventory selling, and hopefully more jobs available so that the employees can then purchase more (and the cycle goes on).  In addition, this historical move is further triggered by the announcement  today that the Consumer Prices dropped more in November than any other month on record (ever!), due in large part to falling gas and energy prices. Based on these numbers, inflation is almost non-existent and now shifts thinking towards fears of deflation. Also today, housing starts for November came in at their lowest level since records began in 1959, and building permits were reported at record lows.   These types of numbers is the effect of the “food-chain” economy-  people are scared so they don’t purchase, then companies lay off because their goods are not purchased, then their laid off employees cant purchase… and the circle of recession goes on and on.   With this historical cut, the Feds are hoping to infuse confidence.  So far, though, the Fed’s aggressive rate reductions have failed to stabilize the economy- hopefully this cut will be one that does the job (we really cant go any lower than 0.00)!

Contrary to popular belief, the Fed or the Fed funds rate does NOT control the fixed rate for mortgages.  The fixed rates are based on the mortgage bonds.    Historically, fixed rates have moved in the opposite direction of a Fed move.  When the Fed decreases the Fed Funds rate, it is typically a bad thing for the bonds (fixed rates).  So what we see is that many times when the Fed Fund decreases, mortgage rates (fixed rates) actually increase.  But wait- there’s more……    J   Along with the announcement today of the Fed Fund historical decrease, the Feds also announced that they will continue to purchase Mortgage Backed Securities (MBSs)- this along with the announcement late last month to buy $600 billion in debt and mortgage-backed securities from mortgage giants Fannie Mae and Freddie Mac should actually push mortgage rates down even lower in the next few days.   We are currently seeing a huge rally in bonds and in stocks.  This rally of the bonds is directly from the MBS announcement, NOT the Fed Fund or Discount Rate historical cut.