Unplanned and unexpected decision comes amid continued economic slowdown blamed on worries over COVID-19, the newest Coronavirus that has now claimed six lives in the U.S.
The Federal Reserve this morning announced an "emergency" rate cut of one half of a percentage point from the benchmark interest rate.
"The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent," Reserve Chair Jerome H. Powell stated. "The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy."
“When the Fed raises or reduces the cost of money, it affects interest rates across the board,” says Greg McBride, CFA, Bankrate chief financial analyst. “One way or another, it’s going to impact savers and borrowers.”
Often, a drop in the interest rate prompts citizens to be more willing to borrow money to make big purchases, such as houses or cars.
"When consumers pay less in interest, this gives them more money to spend, which can create a ripple effect of increased spending throughout the economy," states Bankrate.com.
A drop in the federal funds rate typically causes a responding drop in the prime rate - which impacts short-term interest rates and can sometimes lower the rates that people pay on credit cards. Conversely, a drop in the interest rate can prompt banks to lower the annual percentage yields offered on savings accounts. In rare cases, mortgage rates can be impacted by the Fed's decision to drop the interst rate, Banknote.com stated, but noted that "Interest rates on home loans are more closely tied to the 10-year Treasury yield, which serves as a benchmark to the 30-year fixed mortgage rate." A Home Equity Line of Credit will notice a higher impact than mortgages, although a modest reduction in the interest rate is unlikely to result in a significant reduction in those rates either, McBride said. Auto loans may also respond to the cut in the Fed rate with slightly lower rates on auto loans.
The bottom line is, when the Fed cuts rates, "it's reducing the price of money, incentivizing borrowing and dis-incentivizing savings," said McBride. "It gets money out of bank accounts and into the economy."
The drop in the interest rate is also hoped to prop up the stock market, which has fallen
"Although the relationship between interest rates and the stock market is fairly indirect, the two tend to move in opposite directions—as a general rule of thumb, when the Fed cuts interest rates, it causes the stock market to go up and when the Fed raises interest rates, it causes the stock market as a whole to go down. But there is no guarantee how the market will react to any given interest rate change the Fed chooses to make," states Mary Hall, editor for Investopedia's Advisor Insights.