Breaking News: The Federal Reserve Board today (15 March 2017) raised interest rates .25%, the second time in three months. Further, it hinted that it would raise rates twice more in this calendar year.
Great. What just happened?
Most people, not being wonky economists, think that the Board of Governors (of the Federal Reserve Board, not your state government) voted to raise interest rates on all loans that banks give, and that they decided on what those interest rates will be. The overnight rate has been at .50% for a few short months, and the Fed raised it to .75%.
That would be wrong. It’s so much more entertaining. Our economy is a Keynesian economy. What that means mostly is that it’s a free market enterprise. The market conditions will determine what costs are.
Think about it. If you own your home and now want to sell, your broker will show you market conditions and past sales to help you determine for how much you can sell that home. You can’t just throw a price out there and expect buyers to pay you what you want. That would be foolish.
The Fed has to follow the same rules. It cannot just decide what interest rates will be, change the number on it’s website, and that’s what people now have to pay. Those people will pay what they are willing, and en mass, their actions will determine what that rate will be.
When the Fed “raises interest rates”, it simply means that it will change the way it’s done business in the immediate past. The Fed decides how much money it will sell each month, and it does that in an auction. If it floods the market with a massive amount of money, banks (the buyers of that money) will be able to buy it at a better (lower) price. If it offers less money than usual, the buyers will have to bid higher or lose to another bidder. It’s no different than a farm auction, except that the bankers are all wearing suits and it all happens with computers now.
In short, the Fed doesn’t “raise interest rates”. It decides how much money it will sell in the coming weeks, and in so doing, will help guide the market to what it thinks the value of that money might be.
Having done this for a very long time, the Fed knows approximately how much less money it needs to offer in the auction in order to move prices up approximately .25%. In reality, it has to wait and see what it gets. The real overnight rate will probably end up somewhere between .75% and 1.00%.
The overnight rate is the lowest rate in the country. Every night after the banks close, bank computers borrow and lend to each other in order to be certain that no bank is out of line with federal regulations, that they all have enough money to conduct business the following day, etc. Some banks will have more than they need, so they lend to others until the next night, when it all happens again. That .75% is the interest rate that one bank pays another for that overnight money.
Other interest rates (car loans, mortgages, business loans, etc.) will be determined by what the market is doing, along with what the banks had to pay for the money it will lend. Mortgage interest rates will probably go up over time, but mortgages are some of the longest term debt in the country. Rates won’t automatically increase .25% tomorrow morning.
Other shorter term money will. Look to the interest banks will charge you on your credit cards to increase pretty quickly, along with 60-90 day loans. Interest on auto loans will increase right behind them, as most are 3-5 year terms, but far short of the average mortgage.
I picture the Federal Reserve as a choreographer. And everyone knows that the most beautiful choreography will be upstaged every time by a single dancer falling headlong into the orchestra pit. It has to make the decision, and watch it all play out, just like the general public.
If you’re looking to sell your home or investment property, now might be a good time, before those interest rates start moving up. Call me anytime. I’m always here for you.
Enjoy the day,