Interest Rate Jitters, the Fed & Why We Should Care

Financial marketsWall Street and markets elsewhere were abuzz this week with the jitters over the Federal Reserve’s outlook on the most watched number in the financial world — the federal funds rate.
The target funds rate – the overnight interbank borrowing rate – has been at its historic 0-.25 low since December 2008. But it was the Fed’s nudge upward of the discount rate -what it charges banks on emergency loans – that spooked the global stocks, commodities and foreign exchange markets.  
As Fed Chairman Ben Bernanke has suggested in recent weeks, the discount rate was raised to 0.75 percent from 0.50 percent. And the bellwether federal funds rate was untouched.
The markets were seemingly caught off guard, despite warnings from the Fed that the discount rate move would be “technical” and a step toward “normal footing” in its lending facilities, and not a shift in monetary policy.
Why the jitters?
Wall Street is as nervous about the weak economic recovery as Main Street, and any move on the key policy rate could signal a slower recovery.
Consumers should take notice because any resumption of normalcy with the federal funds rate would be felt in the household budget. It would mean higher rates on credit cards, big-ticket purchases bought on credit, home equity lines and, eventually, primary mortgages.
Most of the shorter-term loan products that consumers pay with interest are tied to the federal funds rate.
Any sooner-than-later increase in short-term lending rates would endanger a still weak housing finance market and possibly deepen the foreclosure crisis. With credit availability for households and small businesses still at near-anemic levels, it would mean that credit card issuers would further push fixed-interest rates higher on future transactions – a practice that is not restricted by the new credit card laws taking effect Monday.
And it would have an impact on variable rate cards – tied mostly to the U.S. prime rate. Banks see the funds rate as the benchmark for setting their prime lending rate for their best customers. Variable rate cards have increased over the last few months as card issuers have shifted more costumers away from fixed rates ­- in part because the new credit card legislation does not apply to rates linked to a variable index.
In the Fed’s minutes for its Federal Open Market Committee meeting on Jan. 26-27, the consensus on credit availability and demand was bleak.
“Overall, net debt financing by non-financial businesses was near zero in the fourth quarter after declining in the third, consistent with weak demand for credit and still tight credit standards and terms at banks,” the Fed’s minutes read.
But the Fed made it clear that its intention was to keep the federal funds rate as it is for an “extended period.” And that the discount rate increase was actually a reflection of the financial sector’s slow-but-steady move away from the strains felt at the crisis peak.
The Fed said it represents “technical adjustments to reflect the notable diminution of the market strains that had made the creation of new liquidity facilities and expansion of existing facilities necessary.”

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