What to Make of the Rate-Cut

In case you missed it, the Federal Reserve cut key interest rates by .5% yesterday.

What? That doesn't send you into a euphoric state?

Me neither, though I can say I was in favor of the cut, because it will likely pull mortgage rates down a little bit and as I'm hoping to sell a house and buy another in the coming months that's a good thing for me (I mean us, my wife and I).

But what does a half-point rate-cut really mean? I guess that kind of depends on who you are.

If you're an investor and your portfolio is in stocks, you probably made some money yesterday and may continue to do so. In general, the stock market likes it when "the Fed" cuts rates. Why? Several reasons.

One reason is that it means borrowing money is cheaper and that factors into business models for the companies they are investing in (i.e. XYZ, Inc. can borrow money to expand operations and drive higher revenues more cheaply, which makes their returns more valuable, because they will have to pay less to service the debt).

A second reason is that the investors (and by that I primarily mean institutional investors, the big guys who work for big firms that manage billions) have more access to cheap cash that allows them to expand what they're doing and improves the outlook on returns.

A third factor for investors is that the rate cut generally bodes well for stimulating the economy at large, which drives spending, which means companies make money, which means stock prices go up, which means they (the investors) make money - in theory.

If you are a consumer and have debt with adjustable rates or are in the market to purchase something that you'll finance, a cut like this will likely reduce the interest rates you'll pay. What this should mean is that you will spend less in interest on the purchase, what it shouldn't mean is that you're going to borrow more than you were before just because you think you can afford more now. Rates change and if you're using a credit card or any kind of adjustable rate financing you have to factor in future rate increases - particularly if the financing will last more than 12 months.

If you are an investor who is primarily in bonds or using some sort of money market or savings account that pays interest this rate cut isn't great for you. You will notice that the rates you get paid on your money will decline in general as a result. Now a half-point isn't going to drastically alter your retirement outlook probably, but will effect what you make in interest over the next few months - depending on where rates go from here.

Financial markets are complex beasts. I don't claim to fully understand them. The fundamental principles that they're built are are fairly simple, but size and time builds complexity until grasping all the nuances is a full-time job. Plus you're dealing with people who don't always make rational decisions - so even when something like a rate cut happens you can't really predict exactly what stock prices will do because there is a human element involved.

I wouldn't get too wound up over this half-point cut just yet. If you're concerned about it talk to your financial adviser (I need to get mine to start paying me to drop his name in stuff like this). I wouldn't go trying to refinance your mortgage just yet, I don't think this is a big enough cut to do you much good by the time you pay the closing costs.

I will say this, however. If your home is currently financed on an ARM (adjustable rate mortgage) that is going to reset anytime in the next 12 months, this might be a good opportunity to try to lock in a fixed rate loan before that adjustment happens (assuming you're not planning to sell the home prior to the reset). Rates could go down from here, but with inflationary pressures still on I'm not sure they're going very far (one other effect of a rate cut is that it can fuel inflation, that's one of the things that keeps the Fed from dropping them way down all the time).

So there it is, several thousand percent more than you cared to know about what it means when the Fed cuts interest rates.