How the Fed's Decision Impacts You

If you have a mortgage, carry credit cards and are considering a home equity loan to cope with soaring food and energy prices, you should be paying attention to what the Fed has to say.

If you are heavily invested in the stock, bond or real estate markets, the Fed's decision will directly have an impact on you over the months and coming years, no matter who gets into the White House. [Make sure you read the end of this article].

On Wednesday, the Federal Reserve held a key short-term interest rate steady, following a series of interest rates cuts - a move that signals to some that rates may soon change direction.

Many assume that means consumer lending rates will rise as well. But the central bank had cut rates seven times since September in an effort to bolster the lagging economy and spur economic growth. During that time, mortgage rates were increasing. So what's going on here? And what should consumers expect loan rates to do next?

How It All Shakes Out

The fed funds rate is often considered a benchmark to set rates for consumers on many types of loans, from mortgages and home equity lines of credit to credit cards and business loans.

Generally, the Fed lowers rates when it is concerned about the economy slowing and raises rates when it is more worried about inflation. In times of lower interest rates, consumers tend to spend more because of the cheap cost of borrowing.

But, according to a recent article at CNN.COM, people incorrectly equate the Federal Reserve's actions with changes in consumer interest rates, cautioned Eric Tyson, author of "Personal Finance for Dummies."

There is not a direct connection, he explained, but an indirect one. "Rates are set by market forces and they have been trending higher in part because of inflationary concerns and, in part, because of Fed expectations." So with inflation fears on the rise and many investors expecting the Fed to raise rates again, mortgage rates have already begun to tick higher.

Rates on 30-year fixed mortgages have surged to a 9-month high on growing concerns about inflation, according to a recent report by mortgage backer Freddie Mac (FRE).

And rather than track the fed funds rate, which is the rate banks charge one another for overnight loans, fixed mortgage rates are more closely aligned with the yield on the 10-year treasury note, which offers a long-term look at a fixed investment.

While the lagging economy has bolstered the yield on the benchmark 10-year note, it still remains at a relatively low level, Tyson said.

Unlike fixed-rate mortgages, adjustable-rate mortgages can fluctuate in response to a number of rates, depending on the terms of the loan. Many are pegged to the Libor rate, an international interbank lending rate.

Others follow the prime rate, which is generally three percentage points higher than the federal funds rate (presently the prime rate is 5%). Credit card companies also tend to move the rates on their variable rate credit cards in line with the prime rate of interest.

"Credit cards are generally tied to the prime rate which usually moves in lock step with the Fed's actions," according to Scott Hoyt, senior director of consumer economics at Moody's Economy.com.

Why It Matters to Us

Even if the Fed leaves rates unchanged, what they say about the economic picture could also influence consumer interest rates in one direction or another. As we all know, the Fed likes to "jaw-bone" and verbally influence the markets.

"Most likely they will express concern about inflation," said Keith Gumbinger, vice president of HSHAssociates.com, an online publisher of consumer loan information, which could send consumer interest rates higher as people take that as a cue that the Fed intends to start raising rates soon.

So if you are wanting to buy a house, now could be the time to pull the trigger before rates rise even further. As Tyson points out, yields on 10-year treasury notes are still relatively low, an indication that 30-year mortgages could still be a good deal.

On the other hand, if housing prices continue to fall, the price reduction on the house might more than offset the increased borrowing costs.

Financing conditions for lines of credit, including home-equity lines, will be tighter than they have been for years. "Keep in mind that it will be difficult to leverage your home's value to greater than 90%," Gumbinger said. So if you do need to borrow against your home equity, now might be a better time than in the near-term future.

According to the CNN.COM article, it is likely that credit card issuers will return to variable interest rates to ride the future anticipated rate hikes, according to Robert McKinley, CEO of credit-card tracker CardWeb.com.

"Consumers should be weighing carefully all card offers they receive in the mail or via the Internet to lock in a good promotional rate or long-term rate, before rates head north again," McKinley advised.

If you carry a balance on your credit card, now is a good time to pay that down as well. But generally speaking, "if you have consumer debt you should get rid of that anyway," Tyson said. [Wonder how this might impact Visa (V) and MasterCard (MA), which are up sharply on the Fed's decision?]

"But since no one can predict for certain what the economy will do, and how the Fed will react, it is generally not a wise idea to make critical financial decisions based on expectations about what will happen with interest rates, he added."

One thing we can virtually assure you, leaving the overnight fed funds rate at 2%, as well as keeping the discount rate as low as it is, is inflationary. The buying (purchasing power) of the economy is sure to be weakened, and the ongoing increases in commodity costs such as energy, food, base metals and precious metal will continue.

The next year or two will tell the whole story clearly. The cost-of-living, including the cost of rent for those who can't afford to buy a home or keep the home they are in, should find millions unprepared and will most likely lead to one of the worst economic crisis in many a decade.

The winners will be those who invest in "the new international money, the new symbol of wealth", gold, silver and the commodities we all use every day to survive (which, by the way, includes water and the upcoming boom in clean, alternative forms of energy).

For those shopping for more bargain-oriented ways to hedge their investments against inflation, the most conservative investments are the gold and silver ETFs (GLD) (SLV).

Also take a good look at some of the beaten-down miners and middlemen such as Silver Wheaton (SLW) which I scooped up more of today when it dipped to $12.59, and Hecla Mining (HL) which might just get caught up in a "short-squeeze" after being manipulated down to a ridiculously low price.

Hecla just sold off it's Venezuelan mines to Rusoro and with their purchase earlier this year of the entire Greens Creek Mine, Hecla is poised for stellar growth over the next year.

You might want to read my June 3rd, 2008 article "Hecla Mining: Best Valued Silver Producer" to see why I'm so bullish on HL over the next year or two.

If you want to invest in a gold producer with no debt, a very low valuation ratio, and almost zero cash costs, it's hard to beat Yamana Gold (AUY) at current prices.

Make no mistake about it, the Fed's decision to leave interest rates this low in the midst of a classic stagflation period will have dire consequences for investors who do not understand the results of a very loose and accommodating monetary policy.

Disclosure: Long GLD, SLV, HL, SLW and AUY.

Comments

[Stockguy456]

great article thanks!!

[GMiki]

GG--Goldcorp--is already up about $2 today. Once the micro mining shares get some short covering, the resource sector should pop.

[GlobalWarmingExaminer]

Good Article. The Fed is clearly keeping interest rates low to bail out the banks. Inflation will eventually start to take up the price of assets like houses and then all the mortgages and lines of credit become good again.
Someone will have to pay for this. The government is effectively debasing our currency so people with savings, bonds, or fixed incomes will fare the worst. Owning real assets as the author described seems like good protection to me. I am currently looking for asset classes other than metals or oil that might offer protection from inflation. Was looking specifically at REITS. If anyone has on opinion on these, post an article or comment.

[Deadeye]

Maybe Mr. Coutenay doesn't know that the gold & silver ETFs are used by manipulators who short sell (probably naked shorts) to bring gold & silver prices down. I would never trust my money to GLD or SLV. This is all being investigated now and someone will be going to jail. I hope.
Otherwise a good article.

[johgonole]

The bankers are thiefs pure and simple. Those of us who wish to keep the purchasing power and security we worked hard for are forced to speculate just to keep what is ours. There too wallstreet and the bankers profit from us.

Bankers get a large cut of GDP simply for allowing us to trade. Our society has become slaves to the bankers in a very real sense.

[ussmls7]

Deadeye, they should be investagateing both Silver & Gold ETF's! After listening to this web cast, the FBI could have a field day, heres the link.! netcastdaily.com/broad..., its lenthly, but well worth the time to let it sink in , I would also have a nice cocktail handy, then you mind wont explode in anger! You think these people would have known that sooner or later,someone would roll over, not all people are heartless a@@holes,but there are many out there,& there will be many to replace the ones that fall in there on crap!

[STILLRENTING]

From the article: "So if you are wanting to buy a house, now could be the time to pull the trigger before rates rise even further. "

BS.

The people competing to buy your home are not buying a price. They are buying a monthly payment. As a buyer I want interest rates as high as possible for several reasons:

1. It means that, all things equal, the price will have to be lowered to keep the monthly payment "doable" for potential buyers.
2. Interest is tax deductible while the price is not. I get a bigger tax deduction with the exact same payment.
3. If I buy when interest rates are high, there is strong probability that I can refinance at a lower rate somewhere down the road.

Meanwhile, if you want to know what happens if you buy at a low interest rate, just look at the current foreclosure figures.

Of course, if I were a seller, I would want interest rates low, for the same reason a car dealership wants rates low. It brings buyers out of the woodwork, allowing you to up your price and get maximum value from your inventory.

In a nutshell: Buyers should want interest rates high and sellers should want interest rates low.

I figure in two to five years interest rates will be back up and prices will be in the tank. It will then be time to buy.