The stock market is rejoicing.
On Wednesday, its best friend, the Fed, once again showed its support by cutting interest rates by another 25-basis point.
In the Fed’s view, the move was necessary to keep the economy afloat and extend the record-long expansion.
While we could debate the effectiveness of these actions, the more important question is what the latest cut means for your finances.
Let’s find out.
A Slight Reduction In Your Expenses
Whenever a central bank reduces interest rates, they are making it cheaper to borrow money.
Take credit cards, for example. Most of them have a variable rate that is directly linked to the Fed’s funds rate.
On average, these drop by 0.60% every time the central bank cuts rates. Meaning that’s one cost you can expect to decrease going forward.
”Note that, if you haven’t already and have the option, I would also suggest switching to a zero-interest credit card.)
Another expense that typically drops when the Fed reduces rates is mortgages. These are linked to Treasury yields, which move in synchrony with Fed funds rates.
However, because mortgage rates have been dropping for some time now, it is unlikely the latest move will impact them. So you probably won’t feel much of an effect here.
Nonetheless, if you own a fixed-rate mortgage, this might be the time to refinance, given that Treasury yields are at historic lows.
Lower Returns On Your Deposits
For much of the post-crisis period, deposit rates averaged around 0.1%.
This has changed in recent years, especially after the Fed started tightening. The highest-yielding accounts now return up to 2.25%, a far cry from the pre-2015 average of 0.1%.
However, if you’re hoping the rise will continue, I’m afraid I must disappoint you.
The latest rate cut signals that the Fed is back in easing mode and that banks can again borrow for less. Meaning they can reduce the rates of deposit they’re paying to the public. I wouldn’t be surprised if these drop back down towards zero.
What About Your Stock Portfolio?
Finally, there’s the stock market.
Given that more Americans than ever own stocks, anything that influences their value should be a major concern.
I expect that the number of investors will keep increasing, considering the current low yields on traditional investments.
If you’re already in the market, then I have positive news. The latest rate cut should increase the value of your portfolio.
One reason has to do with the way businesses calculate the present value of their future profits. They discount based on the prevailing risk-free rate, which is typically the Fed’s funds rate. When it drops, the present value increases, which makes the business more valuable, leading to a higher stock price.
The second reason is that investing in operations isn’t the only reason companies borrow money. Sometimes they borrow for share buybacks, which again elevates a stock’s price. This practice has become increasingly popular in recent years, and I expect it will continue.