Beginning in December 2016, the U.S. Federal Reserve (the Fed) had been gradually ratcheting up the federal funds rate, until it reached its December 2018 level of 2.25–2.50%. Effective August 1, 2019, that changed: The Fed lowered the federal funds rate by a quarter point, to 2.20–2.25%. Even though the announcement was not a huge surprise, it was the first rate decrease since the thick of the 2008 Economic Crisis. As such, the move is receiving wide media coverage accompanied by the usual outpour of opinions on whether it will help or hurt us.
What does the rate change mean to your financial well-being? Is there anything you should “do” to your investment portfolio in response? We typically recommend you remain informed – but you act only on factors you can expect to manage within your personal investing. This is nearly always the case for economic events and other breaking news over which we have no control.
In that context, let’s take a moment to share some insights about the Federal Reserve funds rate.
What Is the Federal Reserve?
As described on its consumer education site, the Federal Reserve is the central bank of the U.S. It was created by Congress as an independent government agency in 1913 “to provide the nation with a safer, more flexible, and more stable monetary and financial system.”
Jerome Powell is its current board of governors’ chair. He and his board are based in Washington, DC. They also oversee 12 regional reserve branches across the country and are tasked with three main roles:
1. Monetary Policy – Promoting “maximum employment, stable prices and moderate long-term interest rates”
2. Supervision and Regulation – Overseeing U.S. banks and gathering information to understand financial industry trends
3. Financial Services – Serving as a bank for U.S. banks as well as for the country’s monetary operations – issuing currency, managing the government’s bank accounts, borrowing money in the form of U.S. Savings bonds and more
What Is Going On?
While you wouldn’t want to run a country without all three of these roles in place, monetary policy is where much of the headline-grabbing action is found. The Fed continuously grapples with when, by how much, and how often it should change the federal funds rate.
The Federal Reserve sets monetary policy through its Federal Open Market Committee (FOMC), which includes the Fed’s board members and a rotating representation of Reserve Bank presidents.
The FOMC holds eight regularly scheduled annual meetings to consider what actions to take – if any. In the days before those meetings, the financial press often reports on expected outcomes as if they were nearly a done deal. Markets often respond accordingly, pricing in whatever is most expected to happen before it actually does. In reality, nobody knows for sure what the outcomes will really be until those meetings have taken place. If the outcome is a surprise, market volatility may result, as prices adjust to the latest expectations.
While the FOMC has a number of ways to seek balance among the competing demands of the economy, raising or lowering the federal funds rate has long been one of its more powerful management tools. So, it’s no wonder the question can grab everyone’s attention whenever the FOMC is set to meet. It’s also no wonder that investors are bombarded with the usual volume of conflicting coverage on what is and is not at stake, and what may or may not come to pass. Depending on who you heed, lower or higher federal funds rates can be anything from a panacea, to a global scourge, to a non-event in the markets.
What Does All This Mean to You and Your Money?
First, it helps to understand that there is an intricate interplay between nations’ monetary policies, global interest rates and the markets in general. Anyone who claims to know exactly what will happen in one arena when we pull a lever in another had best be able to present a functioning crystal ball to be believed.
To cite one example, consider this March 2018 column by Wall Street Journal columnist Jason Zweig, in which he chastises various brokers for their still-anemic sweep account yields despite then-rising interest rates. At the time, he observed: “The Federal Reserve has driven short-term interest rates up a full percentage point since late 2016; one-month Treasury bills were yielding 1.6% this week. But you’d never know any of that from looking at the returns on the cash in your brokerage account.”
The same came happen in reverse. When the Fed lowers rates, you may or may not see similar declines in the loan rates you pay on your mortgage, credit cards, and other consumer debt. That’s because the only interest rate the Fed has direct control over is the U.S. federal funds rate, which is the rate at which depository institutions (mostly banks), lend and borrow overnight funds with one another.
Why is there often a disconnect? It’s partly the result of those multiple global factors at play, with the Fed’s actions representing only one among many others. A post by “The Grumpy Economist” John Cochrane even suggests that the Fed’s actions may be one of the less-significant factors involved: “Lots of deposits (saving) and a dearth of demand for investment (borrowing) drives (real) interest rates down, and there is not a whole lot the Fed can do about that. Except to see the parade going by, grab a flag, jump in front and pretend to be in charge.”
What Should You Do?
Whenever you’re wondering how best to respond to a shifting landscape such as that wrought by falling (or rising) interest rates, begin by asking yourself: What can I do about it?
Unless you are Fed chair Jerome Powell, there is probably nothing you can do to personally influence what the Fed’s decisions will be, or how the global markets are going to respond to them. But there is plenty you can do to help or harm your own wealth interests.
First, if you already have a solid financial plan in place, we do not recommend abandoning it in rash reaction to unfolding news. If, on the other hand, you do not yet have a well-built plan and portfolio to guide the way, what are you waiting for? Personalized financial planning is a good idea in all environments.
Next, recognize that rising or falling interest rates can impact many facets of your wealth: saving, investing, spending and debt. A conversation with a wealth manager is one way you can position yourself to make the most of multi-factored influences in unfolding economic news.
Together and through varied interest rate climates, we can help put these and many other worldwide events into the context they deserve, so you can make informed judgments about what they mean to your own interests. The goal is to establish practical ways to manage your debt; wise ways to save and invest; and sensible ways to spend, before and in retirement.