Fed rate cuts becoming 'counterproductive'

USA Today

The latest Federal Reserve rate cut will further squeeze conservative investors and retirees with modest incomes, while giving little added relief to borrowers already benefiting from prior rate cuts.

"The rate cuts are starting to be counterproductive because of the damage they inflict on income investors," says Peter Crane, vice president of iMoneyNet, which tracks money market funds. "They are cutting the buying power of savers."

Savings rates have fallen hard since the Fed began cutting in January, knocking 2.5 percentage points off the benchmark federal funds rate so far.

Last summer, CD rates were the highest in five years, notes Greg McBride, a financial analyst at Bankrate.com. Today, they are the lowest in seven years.

And that's a substantial drop for savers. If a family put $100,000 in a one-year CD, now yielding on average 3.9 percent, they would earn $1,570 less in interest than if they put the same money in a one-year CD a year ago, when the yield was 5.47 percent, McBride says.

Money market fund rates also are sliding. They started the year above 6 percent, Crane says. He predicts that the latest Fed cut will cause money fund rates to fall to 3.65 percent.

The decline in savings rates hits retirees hardest. "The rate cuts are far more favorable to people in their family-forming years than to people in their senior years," says Clare Hushbeck, an economist at AARP.

One-quarter of Americans 65 or older get 90 percent or more of their income from Social Security, according to an AARP study. Many retirees also are conservative and stick to safe, income-producing vehicles, such as bank certificates of deposit and money market mutual funds.

Younger people are typically much less risk-averse. "They have a heck of a lot more money in the stock market — and it generally benefits from rate cuts," says David Wyss, Standard & Poor's chief economist.

Consumer spending is important to the economy, so the Federal Reserve wants to make sure that taking out a mortgage or borrowing on a credit card is affordable, experts say.

But while savings rates are on a downward spiral, loan rates are a mixed bag.

The rate cuts haven't added up to much in savings for mortgage borrowers so far this year. The average rate on 30-year fixed-rate mortgages is nearly the same as it was in January.

"The Fed's action has created a lower interest rate environment," says Robert Heady, founding publisher of Bank Rate Monitor. "But mortgages are run by the bond market."

Some experts say mortgage rates won't come down much more because the bond market already has factored in the Fed's rate cut.

Robert Van Order, chief economist at Freddie Mac, adds: "The bond market doesn't think there will be a recession, and that's kept rates up."

But home buyers shouldn't be too upset. Mortgages are at historically low rates. Almost a year ago, fixed-rate mortgages were more than 8.5 percent.

Home equity loans are more directly influenced by the Fed's actions. At the start of the year, fixed-rate home equity loans averaged 10.09 percent, vs. 9.07 percent last week, according to Bankrate.com.

Most variable-rate credit cards are linked to the prime rate, so they should go down accordingly. Some issuers adjust rates on a monthly basis, while others do so quarterly.

The average rate on credit cards is 15.73 percent — 14.54 percent on variable-rate cards and 15.98 percent on fixed-rate cards, according to CardWeb.com. That may not sound like a big bargain, but card rates are at the lowest level in seven years, says Robert McKinley, CardWeb.com CEO.