Fed Interest Rate Cut Causes Concerns

The Federal Reserve has cut interest rates by a modest 0.25 percentage points and has managed to concern nearly every sector of the economy. The small small-but-wealthy slice of the population that makes its money buying and selling financial assets expected the rate reduction to be bigger. Savers and those with short-term investments will earn almost nothing in real terms. The average one-year certificate of deposit currently yields just 0.91 percent and has already started to fall.

The interest rate change will affect that broader economy through millions of decentralized decisions. Now, it appears that super-low interest rates are here to stay, and the rates of 20 years ago, when 30-year mortgages cost 8 percent and a one-year bank CD yielded 5 percent, won’t return anytime soon. The stock markets fell after the news, with the Dow dropping 1.2 percent and the S&P dropping 1.1 percent.

The Fed policymakers have now reduced their long-range projection from 4 percent to 2.5 percent, barely above the current level. Its target short-term interest rate has been reduced to between 2 percent and 2.25 percent. The Fed doesn’t usually cut rates just once. Futures markets are predicting another downward move as early as next month.

Aging populations in the developed world partially explain today’s ultra-low yields. Older people don’t buy as many new houses and cars as a younger population does and tend to have money saved for the future. Inflation has been dormant in most major economies, so central banks haven’t seen the need to raise rates to combat inflation. As a result, many predict that rates will be kept relatively low for the foreseeable future.

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