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What the rate cut means for you

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08/01/2019 | 10:38am EDT

On Wednesday, the US Federal Reserve announced that it would cut its rates to try to further prolong growth, as inflation is considered too low. This will have some direct impact on our daily lives…

For the first time in eleven years, the Fed announced an interest rate cut. It was a 0.25 percentage points cut, bringing rates below 2.25%.

This was not enough for Trump, who wanted to see a sharp drop in rates that encourages US citizens to spend, even if it means increasing debt. According to him, the American economy cannot compete against Beijing and Europe, which keep their rates low. While European companies and consumers can borrow at low cost, he believes this is not the case for Americans. He describes this situation as "very unfair to the United States".

Many ripple effects

But now that the Fed has cut its rates, even if it is not as much as POTUS wanted, how will it translate in our daily lives? When the Fed cuts its rates, it encourages the various economic actors to borrow to invest and consume, promoting growth, as the cost of borrowing is lower. In addition, it reduces the cost of debt for governments, businesses and households, improves consumption, investment and strengthens the economy. It should also contribute to increasing prices in the longer term.

However, low interest rates affect banks' profitability, as they earn less money by lending to their debtors. And some economists doubt that lower rates will bolster consumption.

Anyhow, Charles Schwab created an interesting infographic that looks back at the impact of rate cuts in the past. It found that on the short term, yields on cash investments typically fall, CD rates often drop, as well as bank savings rates. With regards to the stock markets, it points out that “although stock markets initially may welcome a rate cut as counterbalance to slowing economic growth, if the slowdown turns into a recession, markets tend to decline after an initial rate cut”.

On the medium term, it found that intermediate-terms bonds can see their price rise more than bonds with shorter maturities. In addition, rates on loans such as pledged asset lines and margins loans may fall gradually.

Finally, on the long term, mortgage rates won’t necessarily go lower, as they track 10-year Treasury yields.

Romain Fournier
© MarketScreener.com 2019
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