COVID-19, also known as the coronavirus, is sweeping the globe and causing significant disruptions to daily life and the economy. As COVID-19 continues to spread, the Federal Reserve has responded by slashing its benchmark by a full percentage point, bringing interest rates to a range of 0 to 0.25 percent. This is the second emergency rate cut this year due to concerns regarding the coronavirus’s effects on the global economy and market conditions. In addition to this dramatic and swift reduction of interest rates, the Fed has announced that it will reinstate quantitative easing (the purchase of hundreds of billions in bonds to keep rates low and markets moving). These measures aim to protect the economy and ease the burden that this virus is causing the markets. Interested in discovering what these changes may mean for you if you’re planning to buy a home? Here’s what you need to know about the Fed’s recent action:
What is the federal funds rate?
By law, banks must keep a minimum amount of non-interest bearing reserves in order to cover depositors’ needs. This amount, known as the reserve requirement, is equivalent to a certain percentage of their deposits. Money that exceeds this required threshold may be lent to other banks. The federal funds rate refers to the interest rate that banks charge each other on an overnight basis.
Eight times a year, a branch of the Federal Reserve called the Federal Open Market Committee (FOMC) meets to set a target for the federal funds rate. The federal funds rate target is dependent upon economic conditions and can vary widely. For example, the federal funds rate reached 20% in the early 1980s due to inflation, and fell to 0 to 0.25% during the Great Recession to drive growth. As the coronavirus threatens markets around the world, the Fed has once again slashed rates to the record low of 0 to 0.25%. Although the federal funds rate has the ability to influence short-term interest rates, this doesn’t guarantee that mortgage rates will follow suit.
What does the federal funds rate affect?
As mentioned previously, the federal funds rate is a target and the Fed doesn’t directly impose the target on banks. However, the Federal Reserve has the power to move rates toward the target by adjusting the money supply. In this case, the Fed’s use of quantitative easing will increase the money supply to encourage lower interest rates.
The federal funds rate usually has an impact on most short-term interest rates. As the federal funds rate rises or falls, we’ll likely see an effect on auto loan and credit card rates. Although it’s possible for mortgage rates to be impacted as well, we haven’t yet seen rates fall following the move by the Fed.
Although the markets are volatile during these unusual times, the Fed’s actions are intended to help the economy remain steady. If you were already planning to purchase a home in 2020, consider speaking with a lender to determine whether you’d like to proceed.
By Michaela Phillips. Michaela is the Vice President of Mortgage Lending at Guaranteed Rate, Inc. Contact Michaela at 303.443.6292, e-mail [email protected] or visit michaelaphillips.com. NMLS: 312874.