In an announcement not unforeseen but nevertheless impactful to the financial world, the Federal Reserve stated on September 16 that they would be maintaining near-zero interest rates for the FED Funds Target Rate through 2023. This news confirmed that over the next few years the Fed will remain committed to stimulating economic growth as a response to the contractions caused by the COVID-19 outbreak. To understand what the Target Rate is, first it must be noted that the Federal Reserve mandates how much cash lenders must keep on hand at the end of each day, this amount is known as the overnight reserve requirement. When banks cannot meet these requirements, they will borrow money from other banks which have excess cash. The FED Funds Target Rate refers to a range of rates that the Federal Reserve sets for these interinstitutional loans that banks make. The Target Rate then in turn influences what is known as the prime rate, which is the baseline rate banks will offer to their most creditworthy customers. Because the prime rate is essentially the minimum rate a lender will charge it serves as the basic building block of all loans. Due the relationship between the Target Rate and the prime rate we can therefore see how the Target Rates serves as a benchmark for all other lending rates within the American economy. The range currently sits at 0.0-0.25% and because of the decision which the Federal Reserve has announced, it is expected to stay there for the next few years.
While it is relatively clear why the Target Rate is of interest to banks and other lenders, it is more important to understand how it affects the average American. Because banks and other lenders typically base their prime rate upon what they themselves must pay in interbank loans, the Target Rate indirectly influences all loan rates in the economy. It has been shown that whenever the Target Rate goes up or down, there is a corresponding change within the rates charged on most loans. This relationship between Target Rate and loans has three important effects for the average American, firstly the Target Rate influences what rates Americans must pay for credit, this extends beyond just mortgages, for example, to include many rates which affect people’s daily lives such as auto loans, credit cards, and home equity lines of credit. Secondly, the target rate also serves as a benchmark for the interest rates on savings and short-term money market accounts. Thirdly, on a macroeconomic level, low rates lower the cost of capital across the entire economy and encourage lending that will stimulate economic activity. Due to the Fed’s decision, we can expect the rates charged by banks for mortgages and other types of loans to stay roughly at the current level or lower for the foreseeable future. Those looking for loans or who are interested in investments that are reliant on interest rates should take note of these developments in their planning over the next few years.
Cheung. (2020, September 16). Fed signals interest rates to stay near-zero through 2023. Retrieved from Yahoo! Finance: https://finance.yahoo.com/news/fed-fomc-monetary-policy-decision-september-2020-135645057.html
Cox-Steib, J. (2020, July 7). How Lower Fed Funds Rate Affects Banks & Lenders. Retrieved from Interest.com: https://www.interest.com/loans/fed-funds-impact-banks/
Federal Reserve. (2020). Open Market Operations. Retrieved from federalreserve.gov: https://www.federalreserve.gov/monetarypolicy/openmarket.htm
Sumrak, T. (2017, November 7). Federal Funds Rate: How the Fed Impacts Interest Rates. Retrieved from lendingtree.com: https://www.lendingtree.com/home/mortgage/how-the-fed-affects-interest-rates/
By: Bray MacIntosh