Fed: Rates to remain at record lows until unemployment improves

By Kelly Dilworth

Thinking about refinancing your home or buying a new car in 2013? Good news: interest rates will be on your side. The Federal Reserve announced Wednesday that it will continue to keep the federal funds rate target near zero -- and is unlikely to raise the federal funds rate until the unemployment rate is below 6.5 percent.

That means interest rates on everything from mortgages to automobiles will likely remain at record lows for some time. The unemployment rate just barely slipped below 8 percent for the first time since 2009 in October, and experts say that the most recent drop in the unemployment rate is partially due to so many people dropping out of the labor force. If those consumers decide that the economy has improved enough to start looking for a job again, the unemployment rate -- which is currently at 7.9 percent -- could rise.

"Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions," said the Fed in a post-meeting statement. "Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed." 

In light of the of the weak economic data and stable outlook for inflation, members of the Federal Reserve Open Market Committee (FOMC) voted to keep the federal funds rate target -- which helps set the rate at which banks trade balances held at the Federal Reserve -- at 0 percent to 0.25 percent.

Moody's Analytics projects that unemployment would reach the 6.5 percent threshold about the first quarter of 2015, or about the same timeframe as the Fed had previously set for maintaining a period of exceptionally low interest rates. But linking rate policy to unemployment, instead of a date on the calendar, gives the Fed more flexibility to respond to conditions, Moody's economic research director Marisa DiNatale said.

The Fed hopes that keeping rates at record lows for the foreseeable future will inspire more consumers to buy a new home, refinance their existing mortgage or borrow cash to buy a new car, say experts. The Fed is also trying to encourage more businesses to invest in supplies -- or hire new workers -- by making loans more affordable than ever.

The Fed's monetary policy has even made credit cards slightly cheaper to borrow with, thanks to a record low prime rate that's tied to the federal funds rate. The majority of credit cards in the U.S., as well as other variable rate loans, such as car loans, are tied to the U.S. prime rate, which is typically 3 percentage points above the federal funds rate. When the Fed raises or lowers the federal funds rate target, borrowers' interest rates usually go up or down as well.  

The Fed's success with spurring more people to borrow, however, has been mixed, say experts.

"The Federal Reserve is basically trying to do everything it can to get this economy back to recovery," says Don Dutkowsky, a professor of economics at the Maxwell School of Public Affairs at Syracuse University. But "with this type of economy, with this type of sluggishness, the effectiveness of their tools is somewhat limited."

The Fed's latest round of bond-buying, which the Fed also voted to extend Wednesday, may spur a boost in confidence in some by signaling to investors, businesses and perhaps even consumers that at least something is being done to encourage economic growth, says Dutkowsky. That, in turn, could have a positive effect on the U.S. economy at a time when policymakers appear to have little appetite for spending government funds on additional economic stimulus, he says.

"Somebody is monitoring the economy," says Dutkowsky. "Somebody is concerned about the high unemployment rate and the sluggish growth and has put that in the priority of policymaking."

That's a big improvement from the U.S. legislature, he says, which is still stuck in a contentious fight over what to do about the country's budget deficit and about how best to avert the so-called fiscal cliff, an automatic series of spending cuts and tax hikes scheduled for Jan. 1.

"The government seems to be stuck on the fiscal cliff," says Dutkowsky. "It doesn't seem they have talked much about how to remedy the economy and get this unemployment rate down to where it needs to be."

The Fed continues to face steep economic challenges
Experts expect that the Fed will continue to make boosting the economy with record low rates a top priority in 2013.  

Already it has kept the federal funds rate target at rock-bottom since 2008. However, forces outside the Fed's control, such as consumers' and small businesses' weak appetite for credit has made it tough for the Fed's policies to make much of an impact.  

For example, the growth in consumer borrowing over the past four years has largely been powered by an explosion in student loan debt, says Rebel Cole, a professor of finance at DePaul University. Credit card debt has increased somewhat, but not by much, according to data from the Federal Reserve.  

Meanwhile, the number of people buying new homes and automobiles has improved, but not at the rate the economy needs to spur more robust growth. Even consumer spending, which improved substantially over the summer before dipping somewhat in the fall, is not strong enough to push the economy out of the trough it's been in since 2008, say experts.

"Small businesses need customers, not credit," says DePaul University's Cole. Businesses aren't borrowing because they don't have a regular customer base they can count on, he says.

Many small businesses are also waiting to hire new workers until after they have more certainty about what their taxes will be like after the first of the year, he says.

"Uncertainty about the much-discussed tax overhaul has indeed created a great deal of uncertainty that has impacted capital investment and hiring decisions," says Cole, referring to discussions about the "fiscal cliff."

"Small business owners have no idea what their tax rates will be in coming years, except higher," says Cole. "More importantly, they have no idea what is going to happen to capital gains, which are scheduled to go up, and potentially could go back to the same as ordinary income ... This could have a major adverse impact on investment, especially in real estate. Add in the uncertainty about the thousands of targeted tax credits, all of which are on the table, and you have a prescription for procrastination until 2014," says Cole.

Consumers, meanwhile, are facing a tough lending environment, says Cole, that makes it difficult to secure a loan, even if they want one.

With mortgage rates at historic lows, "many people would be buying, refinancing or buying if they could qualify for a mortgage," says Cole.

However, many lenders are keeping their lending standards tight, he says, and are reserving the best mortgage rates for consumers with pristine credit.

So for many customers, "even if they get approved, they're not going to get approved for something like a 3 percent mortgage. They're going to get approved for a 6 percent mortgage."   

Published: December 12, 2012

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