This morning, the Federal Reserve cut the fed funds rate by half a percentage point to 1.5%. Today’s rate cut is making more news than usual because it was done in coordination with banks around the world.
Why the Rate Cut?
When the Fed cuts interest rates, it eventually trickles into the economy with hopes to rejuvenate spirits during this tough time. Essentially, by reducing these key interest rates, it becomes less expensive for consumers and businesses to spend money. Remember that the fed funds rate generally has a direct correlation between credit cards, automobile loans, business loans, and home equity lines. As for mortgage rates, the effects are a bit tougher to predict.
Fed Rates and Mortgage Rates
Historically, a reduction in these rates will eventually yield to lower mortgage rates - but this is no guarantee. In fact, during our last round of rate cutting, thirty year fixed mortgages saw an initial increase in mortgage rates. As of right now, investors are wary of investing in mortgage debt because of the recent toxic mortgages that have been plaguing banks. It is also worth noting that the current spread between mortgage rates and the fed funds rate is unusually high.
Global Rate Cut and Fears of Inflation
In this past year, there were a series of rate reductions which brought us to a 2% fed fund rate seemingly overnight. It’s been awhile since we’ve seen another rate cut and the reason is primarily due to fears of inflation. Well, people are still worried about inflation, but as of right now, this mortgage crisis has presented greater problems at hand. In order to uplift this economy, without exacerbating inflation fears, central banks around the world have cut their rates at the same time. These central banks include banks in the UK, European Union, Switzerland, Sweden, Canada, and China.
Back in August, I had written a post titled “Next Move For Fed Fund Rate Will Be an Increase“. And here we are today. So what does this all mean? We’re starting to see the mortgage crisis spread well past localized markets. The increase in foreclosures in California isn’t just affecting California. Its reach has spread well past the U.S. Economy and into our global economy.
Had their not be a worldwide central bank rate cut, the fed fund rate would have likely stayed at 2% due to inflation fears. But the crunch is just too strong, and something had to give. For those of you who followed the series of fed rate cuts, you should know by now that the fed fund rate is tied directly to home equity loan mortgage rates. While this rate cut comes during a tough time in our economy, it may also be the right time for you to looking into relatively cheap home equity loans.
Quick Links:
New York Times - Q&A about Fed Rate Cut
The Guardian - See What Economists Have to Say About Today’s Cut
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