Dollars & Sense

How the Fed’s pullback of the stimulus could affect you

Updated: 2013-12-20T02:30:03Z

By PAUL WISEMAN

The Associated Press

Consumers are likely to pay more for home loans. Savers may earn a few more dollars on CDs and Treasurys. Banks could profit. Investors may get squeezed.

The Federal Reserve’s move Wednesday to slow its stimulus will ripple through the global economy. But exactly how it will affect people and businesses depends on who you are.

The drop in the Fed’s monthly bond purchases from $85 billion to $75 billion is expected to lead to higher long-term borrowing rates. That means loan rates could tick up, though no one knows by how much.

The move could also weigh on stock markets from the U.S. to Asia, even though the early response from investors was surprisingly positive.

Just keep in mind: The effect of the Fed’s action is hard to predict. It will be blunted by these factors:

• It’s a very slight reduction. Though it’s coming sooner than many economists had forecast, the cut is less than some expected.

• Even though it will buy slightly fewer bonds, the Fed expects to keep its key short-term rate at a record low “well past” the time unemployment dips below 6.5 percent from today’s 7 percent. Many short-term loans will remain cheap.

“They have tried to sugarcoat the pill,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics.

• The Fed thinks the economy is finally improving consistently. An economy that can sustain its strength can withstand higher borrowing rates.

All of which suggests that while Wednesday’s action marked the beginning of the end of ultra-low interest rates, the pain may not be severe.

The Fed’s bond purchases, begun in the fall of 2012, were meant to stimulate the economy. The purchases were designed to lower mortgage and other loan rates, lead investors to shift out of low-yielding bonds and into stocks, and prod consumers and businesses to borrow and spend.

Here’s a look at the likely effects of the Fed’s decision:

Consumer and business loans

Mortgage rates have already risen in anticipation of reduced Fed bond purchases. The average on a 30-year U.S. fixed-rate mortgage has increased a full percentage point this year to 4.47 percent. Analysts say it’s likely to head higher now.

“Homebuyers aren’t going to be happy,” said Ellen Haberle, an economist at the online real estate brokerage Redfin. “In the weeks ahead, mortgage rates are likely to reach or exceed 5 percent.”

Still, higher mortgage rates aren’t likely to kill the recovery in the housing market. As the job market strengthens and consumers grow more confident, demand for homes could more than make up for slightly higher mortgage rates.

“It’s a better economy that gets people to buy houses,” said Greg McBride, senior financial analyst at Bankrate.com.

Likewise, an improving economy means stronger sales for businesses, even if they also have to pay a bit more for loans. And rates on auto, student and credit card loans are unlikely to change much. They’re tied more to the short-term rates the Fed is leaving alone.

Savers

Savers have suffered from the Fed’s low-interest-rate policy. Wednesday’s move could offer some relief to people who keep money in three- and four-year CDs. But it probably won’t mean a big jump from, say, the average 0.48 percent rate on 3-year CDs.

“They’re starting from such a low point, it’s not going to be nearly enough to make three- and four-year CDs anywhere near compelling,” McBride said.

By keeping short-term rates near zero, the Fed move does nothing for people with money in savings accounts and very short-term CDs.

Banks

Banks earn money from the difference between the short-term rates they pay depositors and the longer-term rates they charge consumers and businesses. The gap reached a five-year low in the middle of this year. But it’s likely to widen as longer-term rates rise and short-term rates stay fixed. Bank profits should rise as a result.

Banks will also benefit if an improving economy leads more creditworthy businesses and consumers to seek loans.

Financial markets

The Fed intended its bond purchases, in part, to push bond yields so low that investors would move money into stocks, thereby driving up share prices. Since mid-November 2012, the Dow Jones industrial average has surged 28 percent.

Many Wall Street analysts feared stocks would plummet once the Fed announced a pullback in its bond buying. On Wednesday, the opposite occurred: The Dow rocketed 293 points. Investors appeared to focus more on the good news (the economy is improving) than the bad (the easy-money days may be ending).

The celebration might not last.

“As the tapering continues, there will be less liquidity going into the stock market” and the rally will either slow or end entirely, said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University.

Deal Saver Subscribe today!

Comments

The Kansas City Star is pleased to provide this opportunity to share information, experiences and observations about what's in the news. Some of the comments may be reprinted elsewhere on the site or in the newspaper. We encourage lively, open debate on the issues of the day, and ask that you refrain from profanity, hate speech, personal comments and remarks that are off point. Thank you for taking the time to offer your thoughts.

The Kansas City Star uses Facebook's commenting system. You need to log in with a Facebook account in order to comment. If you have questions about commenting with your Facebook account, click here