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Fed cuts interest rates for the first time since 2008

The rate cut could take a while to positively impact card holders, if at all

Summary

The preemptive move aims to ward off downside risks from a slowing global economy, and the uncertainty of trade talks.

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The Federal Reserve on July 31 elected to cut interest rates for the first time since 2008.

During its July meeting, the rate-setting Federal Open Market Committee announced a rate cut of 0.25 percentage points, which takes down the target federal funds rate to the 2.0 percent to 2.25 percent range.

Announcing the move, the Fed said, “In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.”

Considering that Fed Chairman Jerome Powell had previously pointed to rising global uncertainty around trade wars, slowing global growth, the potential for a messy Brexit (the U.K.’s exit from the European Union), as well as below par inflation and business investment in the U.S., market participants had been anticipating this move.

In a post-meeting press conference, Powell noted, “We see this action as designed to support against risks,” expecting the move will work through “confidence channels as well as mechanical channels.”

How the rate cut will affect cardholders

What is notable for credit cardholders is that this is the first Fed rate cut since the Credit Card Accountability Responsibility and Disclosure Act (Credit CARD Act) was signed into law.

Ted Rossman, CreditCards.com’s industry analyst, points out that the legislation created more of a tie between credit card rates and Fed rate actions, but card issuers still retain some flexibility.

Although the target Fed funds rate has risen 2.25 percentage points since the U.S central bank began its tightening cycle in December 2015, CreditCards.com’s data points to a 2.81 percentage point rise in the average credit card rate during that time.

With appropriate notice to cardholders, issuers could resort to some tricks to boost their margins, says Rossman.

“A structure such as the prime rate plus 12 percent could become prime plus 12.25 percent, for instance,” he said. “Some issuers have clauses that allow them to use the highest prime rate published in the Wall Street Journal over the past 60 days, and others reevaluate the rate only once a month. So even if the rate cut does filter through to cardholders, it could take a month or two.”

Issuers could also act on other fronts so that they don’t take a hit to their revenues. For instance, they could raise your annual fees or foreign transaction fees. They could also shorten the term for 0 percent APR balance transfers, or even raise balance transfer fees.

Lynn Reaser, chief economist at Point Loma Nazarene University in San Diego, pointed out that they could also tighten their eligibility requirements to cut down on potential defaults.

See related:  First interest rate cut since CARD Act appears imminent

What should cardholders do?

Reaser doesn’t expect that credit card holders will see a reduction in their interest rates.

“Banks’ profitability margins would be squeezed to unsustainable levels,” she said.

However, Scott Hoyt, senior director at Moody’s Analytics, noted that card issuers could also benefit from lower rates as their cost to borrow money declines as well, which means they may not need to raise their fees or lower rewards to mitigate the impact of lower rates.

In any event, cardholders should do whatever they can to avoid paying interest charges. The average credit card APR is 17.8 percent, according to the CreditCards.com Weekly Credit Card Rate Report.

Rossman advises that you could pay your bills in full, if you can, thereby avoiding finance charges. If you’re carrying a high balance that you can’t pay off within a few months, you could also sign up for a balance transfer card with a promotional 0 percent APR.

Considering that the average household with credit card debt owes $5,700 (according to the Fed), Rossman notes, “The interest costs can be enormous. If you only make minimum payments towards $5,700 in debt at 17.8 percent, you’ll be in debt for 235 months and will pay $7,499 in interest. At 16.8 percent, the payoff time is 233 months and the total interest cost is $7,054 – still a very long time and a very steep price.”

See related:  Sanders, Ocasio-Cortez propose capping credit card interest rates at 15%

More cuts on the horizon?

What remains unclear is whether there will be any further rate cuts this year. Although the Fed is monitoring trade policy developments, Powell disclaimed, “We are not criticizing trade policy. That’s not our job.” He also stressed, “We never take into account political considerations,” when asked about the impact of President Trump’s recent push for a rate cut.

Reaser, who anticipated today’s rate cut, is expecting another quarter-point rate cut this year, likely in October, “as the economy continues to be hobbled by weak business investment spending in the face of ongoing trade frictions between China and the U.S.”

However, she doesn’t see much further economic benefit from future rate cuts.

“A Fed rate cut may have little or no impact in spurring faster economic growth, spurring more inflation or preventing a future downturn,” Reaser said. “The negatives of further hurting savers and elevating risk-taking and leverage in financial markets are also significant costs.”

Powell also stressed that “overall financial stability vulnerabilities are moderate.” However, the Fed is carefully watching business sector moves to get loans off balance sheets and into market-based vehicles, a practice that could lead to danger through high use of debt financing.

He sees this rate cut as a “mid-cycle adjustment,” and doesn’t anticipate a series of rate cuts. If this cut has the desired effect, the Fed might well have to start raising rates again, as has happened after mid-cycle adjustments in past cycles.

Hoyt expects that the Fed, after going through with today’s cut, will likely pause through next year.

And according to commentary from Moody’s Analytics economist Ryan Sweet, “We believe markets are ahead of their skis anticipating additional easing beyond July. Fed funds futures put the odds of a 25-basis point cut in September at 75 percent. Beyond July, the Fed will attempt to return to its data dependence pledge.”

Consumers continue to support economic growth

Recent economic data haven’t been particularly soft, with the government reporting that the U.S economy grew 2.1 percent in its first estimate of economic output for the second quarter.

Consumer spending, which accounts for almost 70 percent of U.S. economic output, remains robust, as evidenced by a 0.3 percent rise for June. Consumer confidence also remains high as employment gains continue to boost spending, with the Conference Board pointing to a rise in its consumer confidence index for July.

Powell noted that the Fed is getting feedback from “low and moderate-income” communities that they’re at last feeling a positive impact from the expansion. And he sees no reason why this expansion can’t continue.

In an online post, Lynn Franco, senior director of economic indicators at the Conference Board, noted, “Consumers are once again optimistic about current and prospective business and labor market conditions. In addition, their expectations regarding their financial outlook also improved. These high levels of confidence should continue to support robust spending in the near-term despite slower growth in GDP.”

Inflation is still running below the Fed’s targeted 2 percent rate, though. The Fed’s preferred inflation index, the Personal Consumption Expenditure index, rose 1.4 percent in June from a year ago. And PCE excluding unstable food and energy prices was up 1.6 percent.

See related:  Fed: Card balances jumped by $7.2 billion in May

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Published: July 30, 2019

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Credit Card Rate Report Updated: November 13th, 2019
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16.97%
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17.16%
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17.01%
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17.23%

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