Sighting: What Do the Fed Rate Cuts Mean?
On September 18, the Federal Reserve lowered two key interest rates by one-half percent. In response, the Dow jumped 300+ points. Obviously, institutional investores were pleased, but what are the implications for consumers? From Bankrate.com:
• Adjustable-rate mortgages. Rates on ARMs are primarily tied to short-term indexes, such as the the one-year Treasury or the London Interbank Offered Rate (LIBOR).... The one-year Treasury and the LIBOR tend to pretty quickly follow moves in the federal funds rate. As the Fed boosts or cuts short-term rates, ARMs are far more sensitive after the fact than fixed-rate mortgages. Conclusion: ARMs are sensitive to Fed rate changes.
• Fixed-rate mortgages. Fixed mortgage rates aren't directly tied to Fed interest rate moves. Instead, they're closely tied to long-term government bond yields, such as the 10-year Treasury, which tend to move in accordance with the economic outlook, inflationary expectations, and in advance of moves by the Fed. Conclusion: Fed rate changes do not have much of an effect.
• Home equity loans. Rates for home equity loans are fixed, so rate changes won't affect existing borrowers. Small, short-term home equity loans are often tied to the prime rate, which moves in close concert with Fed interest rate changes. If the Fed is cutting rates and there's no immediate need for a small loan, consider holding off to see if the Fed drops rates even further. Larger home equity loans, paid back over 10 or 15 years, will track more closely to long-term interest rates, much like fixed-rate mortgages. Conclusion: Fed sensitivity depends. If you have a loan or are considering a long-term loan, no real effect. If you are considering a short-term loan, which are tied to prime, pay attention.
• Home equity lines of credit. HELOC rates closely mimic moves in the prime rate. You'll likely notice changes in one or two statement cycles. Conclusion: Lines of credit are sensitive to Fed rate changes.
• Certificates of deposit, or CDs. Yields on certificates of deposit move with Treasury securities of similar maturity, as they compete for the consumer's dollars. Longer-term CDs, such as the five-year, typically move well in advance of a Fed interest rate move. Competition plays a large role in CD interest rates because deposits can be an attractive source of low cost funds for banks. That competition can keep yields propped up a bit early on in a declining rate environment, but the downward trend will gain momentum when the Fed cuts. Conclusion: Yields generally move in advance of a Fed rate change, but competition among institutions also affects interest rate offers.
• Money market accounts, or MMAs. Yields on bank money market accounts are closely tied to what the Fed does with short-term interest rates. In a falling rate environment, you can be sure many of them will reduce returns pretty quickly when the Fed cuts. Conclusion: MMA yields are sensitive to Fed rate changes.
• Money market mutual funds, or MMMFs. Yields on money market funds follow Fed moves, but it can take nearly three months before a move is completely reflected in money fund yields, as short-term investments within the fund mature and are reinvested at the new, lower rates. Conclusion: MMMFs are sensitive to Fed rate changes. 
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