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Published: 1/5/2014 - Updated: 3 months ago

MONETARY ACTION

Key factors could affect impact of Fed pullback

Global economy to feel end to stimulus program

ASSOCIATED PRESS
Federal Reserve chief Ben Bernanke announced the move as the U.S. economy gained steam. Federal Reserve chief Ben Bernanke announced the move as the U.S. economy gained steam.
ASSOCIATED PRESS Enlarge

WASHINGTON — Consumers will likely pay more for home loans. Savers may earn a few more dollars on CDs and Treasurys. Banks could profit. Investors may get squeezed.

The Federal Reserve’s move last month to slow its stimulus will ripple through the global economy. But exactly how it will affect people and businesses depends on who you are.

The drop in the Fed’s monthly bond purchases from $85 billion to $75 billion is expected to lead to higher long-term borrowing rates. Which means loan rates could tick up, though no one knows by how much.

The move could also weigh on stock markets from the United States to Asia, even though the early response from investors was surprisingly positive.

Just keep in mind: The impact of the Fed’s action is hard to predict. It will be blunted by these factors:

● It’s a very slight reduction. Economists had expected the Fed’s monthly purchases to be cut more than they were.

● Even though it will buy slightly fewer bonds, the Fed expects to keep its key short-term rate at a record low “well past” the time unemployment dips below 6.5 percent from today’s 7 percent. Many short-term loans will remain cheap.

“They have tried to sugarcoat the pill,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics.

● The Fed thinks the economy is finally improving consistently. An economy that can sustain its strength can withstand higher borrowing rates.

All of which suggests that while this action marked the beginning of the end of ultra-low interest rates, the pain may not be very severe.

The Fed’s bond purchases, begun in the fall of 2012, were meant to stimulate the economy. The purchases were designed to lower mortgage and other loan rates, lead investors to shift out of low-yielding bonds and into stocks, and prod consumers and businesses to borrow and spend.

Here’s a look at the likely effects of the Fed’s decision:

Mortgage rates already have risen in anticipation of reduced Fed bond purchases: The average on a 30-year U.S. fixed-rate mortgage has increased a full percentage point this year to 4.47 percent. Analysts say it will likely head higher now.

“Homebuyers aren’t going to be happy,” said Ellen Haberle, an economist at the online real-estate brokerage Redfin. “In the weeks ahead, mortgage rates are likely to reach or exceed 5 percent.”

Still, higher mortgage rates likely won’t reverse the recovery in the housing market. As the job market strengthens and consumers grow more confident, demand for homes could more than make up for slightly higher mortgage rates.

“It’s a better economy that gets people to buy houses,” said Greg McBride, senior financial analyst at Bankrate.com.

Likewise, an improving economy means stronger sales for businesses, even if they too have to pay a bit more for loans. And rates on auto, student, and credit-card loans are unlikely to change much. These rates are tied more to the short-term rates the Fed is leaving alone.

Savers have suffered from the Fed’s low-interest rate policy. The Fed’s move could offer some relief to people who keep money in three and four-year CDs. But it probably won’t mean a big jump from, say, the average 0.48 percent rate on three-year CDs.

“They’re starting from such a low point, it’s not going to be nearly enough to make three and four-year CDs anywhere near compelling,” Mr. McBride says.

By keeping short-term rates near zero, the Fed move does nothing for people with money in savings accounts and very short-term CDs.

Banks earn money from the difference between the short-term rates they pay depositors and the longer-term rates they charge consumers and businesses. The gap reached a five-year low in the middle of this year. But it’s likely to widen as longer-term rates rise and short-term rates stay fixed. Bank profits should rise as a result.

Banks also will benefit if an improving economy leads more credit-worthy businesses and consumers to seek loans.

The Fed intended its bond purchases, in part, to push bond yields so low that investors would move money into stocks, thereby driving up share prices. Since mid-November 2012, the Dow Jones industrial average has surged 28 percent.

Many Wall Street analysts feared stocks would plummet once the Fed announced a pullback in its bond buying. After the Fed's announcement, the opposite occurred: The Dow rocketed 293 points. Investors appeared to focus more on the good news — the economy is improving — than the bad — the easy-money days may be ending.

The celebration might not last.

“As the tapering continues, there will be less liquidity going into the stock market,” and the rally will either slow or end entirely, said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University.

Over the last year, the super-low U.S. rates had led investors to seek higher-yielding investments in emerging markets.

Last summer and fall, speculation about a slowdown in the Fed’s stimulus sent stocks tumbling in the developing world.

Indonesia’s market has sunk nearly 19 percent since investors began anticipating the Fed move in May. Stocks in Thailand are down 18 percent.

Without Fed policy driving cash into developing markets, these stock markets might have further to fall.

Mark Olson, a former Fed governor, said the central bank succeeded in convincing investors that a slight pullback in bond purchases is hardly the same as tightening interest-rate policy.

The stimulus continues — through record-low short-term rates and the continuing, though reduced, bond purchases.

“And for once,” Mr. Olson said, “I think the markets read it the way the Fed had hoped.”



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