The Federal Reserve controls one interest rate. How does that affect all the others?
The Federal Reserve controls one interest rate. How does that affect all the others?
Maybe you are one of many Americans who, for over two years, have been holding their breath on making that next life move.
“How long can I keep driving this car? How long do I have to stay in my parents’ basement? When can I start my life with homeownership and starting a family?” are questions some people might have, said Stephanie Kelton, an economist at Stony Brook University.
Kelton doesn’t have answers to those questions, which for some consumers depend on the levels of interest rates for auto loans, mortgages and credit cards. But she does have a long-term projection that requires patience.
“This is a very cautious Fed,” she said. “And I would expect them to go very slow.”
That’s because the Federal Reserve doesn’t want inflation and interest rates to jump around like a seesaw. If it drops rates too quickly, inflation could ramp up and the central bank would have to raise rates again, jostling the economy back and forth.
No one has a crystal ball, but plenty of people are trying to guess when the Fed will lower interest rates. Many financial pros expect the first cut to come in September. If and when the Fed acts, what will it mean for consumers who need to borrow money?
In general, interest rates in the economy move in concert with the level of the interest rate the Fed directly controls, called the federal funds rate. If the Fed moves slowly, interest rates for things like mortgages, car loans and credit cards will also change slowly.
“You can think of [the federal funds rate], in a way, as kind of an anchor for all other interest rates,” Kelton said.
And those other rates might follow the Fed at their own pace.
Take auto loans: They tend to be riskier for lenders because all kinds of people, including people who are more exposed to financial emergencies, use them. It’s why car loans and credit cards can have higher interest rates than mortgages.
“The auto market serves all,” said Jonathan Smoke, chief economist at Cox Automotive. “And the mortgage market is way more cookie-cutter in terms of who at the end of the day actually can get a mortgage.”
People who can afford to buy a house usually have more cash reserves.
Auto loan rates may take even longer to fall because consumers are having a hard time paying their auto debt.
“We basically have very high severe delinquency rates on auto loans, meaning more consumers are behind 60 days or more on a percentage basis than we’ve seen in the last 20 years,” said Smoke, adding that defaults have gone up too.
There are always interest rate exceptions, though. Car dealers might offer lower rates to coax you into buying models they want to offload.
These industry specifics aside, big picture, consumers might not have to wait that long to see lending rates fall, at least a bit.
“It’s not just what the Fed does, but what they expect it to do,” said Frederic Mishkin, a former member of the Fed’s Board of Governors.
Lenders try to anticipate the Fed’s movements. It’s a bit of a cat-and-mouse game to make sure their lending product is as attractive as possible against the competition.
“People make money on their bets, right?” Mishkin said. “So, they expect something to change just because there’s a speech. That’ll actually affect interest rates.”
It’s why mortgage rates have dropped recently, even though the Fed hasn’t cut rates at all.
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