In a surprise to the markets Thursday after the close, the Fed raised the Discount Rate from .50% to .75%, a raise of one-quarter point. While this small raise may seem relatively small measure-wise, it was the first raise of the Discount Rate since August of 2007. The significance? Well, the big question is: does this raise signify a turnaround of the Fed’s view of the markets, and is it the start of an upward trend in interest rates?
The discount rate (in case you were wondering!) is the rate that the Fed charges to banks for short term loans. While the loan timeframes have been up to 90 days, this raise also changed the term to overnight loans. Stocks retreated in after-market trading. In fixed markets, Treasury prices fell and yields jumped.
It is clear that for US monetary policy to keep interest rates essentially at zero for an indefinite time is both unsustainable and unrealistic. The interest rate cycle, which runs roughly 5-8 years from bottom to top historically, has already exceeded its timeframe to stay on the bottom end- to expect it to stay at a virtual zero rate is the thing fairy tales are made of. The bigger question that faces the market is this: is this raise the start of a continued upward trend in interest rates? In a statement along with the announcement, Fed Chairman Bernanke said “The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook of the economy or for monetary policy.” The consensus among the pundits is that this is a one time thing and rates will stay at these levels until the beginning of 2011- only time will tell.
How does this affect you? If interest rates begin an upward trend, adjustable mortgages will adjust up, credit card rates will climb (as if they are not high enough) and the general cost of goods will go up due to additional costs to manufacturing, transport, labor, goods, etc. Realistically, this means the annual costs to run your household or business will rise accordingly.
If you are paying off loans for the past few years, you have found that with low interest rates more of your payment is applied to principal, paying down the loan quicker. With rising rates, more of your payment will be applied to the interest portion, slowing down the reduction of your outstanding principal amount. If you can, while rates are still low, pay off as much as you can so as to reduce your principal loan as much as possible before rates rise. If you are considering a sizable purchase in the near future, if you can, move up your purchase date and lock in the current, relative low loan rates- money is cheap now…take CAREFUL advantage of it. Things won’t stay this way forever.
For every Yin there is a Yang…stay tuned! What do you think?
