Market Musings: Interest Rates

Even if your heads been under a rock for the last five years, you still probably know that interest rates on things like mortgages, car loans, home equity lines, and interest income on savings accounts are around historic lows.

This post could be turned into book but I’m trying to keep this post short and simple.  They’ll be more posts based around this topic and number of the topics I’ll touch on today.

In the US and most countries around the world, their banking system is controlled by a Central Bank.  In the US that bank is the Federal Reserve.  The Federal Reserve has a Federal Open Market Committee (FOMC), this group that decides on the Federal Funds Target Rate, which is what most people will refer to as the interest rate. The FOMC has about eight regular meetings a year to determine the federal funds rate, most people call it the fed funds rate, along with other open market activities.

What is the Fed Funds Rate?

Basically, it’s the rate that commercial banks charge each other for overnight loans.

Who’s the FOMC?

The committee is made up of 12 voting members which consists of the seven Federal Reserve Board Members and five of the twelve Federal Reserve Bank Presidents, four of the presidents rotate every year.  It’s kind of complicated and political, which you might find surprising for a supposed nonpolitical entity.  Will be another blog post.  The only person you really need to care about or should know is Janet Yellen, the Chair of the Federal Reserve System.  She’ll be the person on TV or in the news.  It’s really her opinion that matters.

If you turn on CNBC, everyone will be freaking out about either upcoming FOMC, post meeting statement, or the minutes.  The minutes are released until three weeks after the date of the policy decision.   There are many people who make a career about predicting the out coming of FOMC meeting and if rates will raise or fall, especially the language used in the minutes.  One word can spend the market off a cliff or skyrocketing.  For example, a few weeks ago Yellen basically said she’ll take her time raising rates, which the markets love to hear, and it sent the market straight up.

What’s the point?

The FOMC handles National Monetary Policy.  What is Monetary Policy?  It’s the actions of regulators like the Fed to determine the size and rate of the money supply.  This ultimately determines the availability of banks to make loans.  Since January 2009, the Fed Funds Rate has been in its current range of 0 – 0.25%, which was my entire career in investment management.  It wasn’t a great time to work at a company with most of its assets in money market mutual funds.

Now there are talks about the FOMC raising rates later this year.  It looks like it’s going to happen but I can’t tell you how many times I heard people say that rates are going to rise later this year.  I guess I’m immune to it.

Either way, most people should completely ignore all the interest rate talk. People and advisors will be trying to tell you what you need to do in a changing rate environment. For 99.999% of the people, it doesn’t really matter

In the mid 2000s, everyone said you should buy a house because rates were really low, so low that they may never be this low again.  What happened? They got lower and everyone refinanced their homes.