Fed finally bumps up interest rates; consumer effect minimal in short run

By raising short-term interest rates a quarter of a percentage point from zero on Wednesday, the Federal Reserve finally ended its seven-year emergency stimulus, put in place to lift the U.S. economy out of a free fall.

The long-anticipated rate increase - the timing of which had been hotly debated in financial markets and among Fed policymakers - sends a powerful symbolic message that the economy has recovered from the Great Recession, but it is not expected to have a major effect on most consumers.

The rate bump is the first for the central bank since 2006.

"We can't claim we're free of the dark pull of the Great Recession until interest rates are off zero," said Mark Zandi, chief economist of Moody's Analytics. "Zero is not consistent with a healthy economy. It's a good thing that we're now at a point where interest rates should be normalized."

The small increase in the so-called federal funds rate, which big banks pay one another for overnight loans, is expected to have little benefit for savers, who for years have earned virtually nothing on money in their bank accounts and certificates of deposit. However, it will trigger a small boost to the prime interest rate, a key measure banks and lenders use to set credit-card and auto-loan rates.

Consumers carrying credit-card balances and other forms of short-term, variable-rate debt, such as home-equity lines of credit, will face higher monthly payments, experts said.

In a statement explaining its decision, the Fed's policy-making committee "judges there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium-term, to its 2 percent objective."

The Fed cautioned that it expects slow economic growth to warrant only "gradual" increases in interest rates over the next few years.

Different forces drive mortgage rates, so they are not expected to be changed by the Fed's bump in rates.

Raising rates now is an extraordinary move.

"When you look at history and the Fed raising rates, typically they are doing it either to combat inflation to stabilize prices or to slow down economic growth, so that the economy doesn't overheat," said Tom Cassidy, chief investment officer for the wealth management division of Univest Corp. of Pennsylvania, a banking company based in Souderton.

That's not the case now, with the economy far from robust for many.

The Fed is raising rates now to "get off an emergency policy," Cassidy said.

Doing so was crucial, experts said.

If the Fed gets the federal funds rate up to 1 percent by the end of next year, as Fed officials have suggested as a target, the central bank would be closer to where it could cut rates when there is another economic downturn.

But getting to 1 percent would have a cost to some.

According to the Consumer Financial Protection Bureau, a person carrying $15,000 in credit-card debt at an average rate of 12 percent would face an additional monthly interest charge of nearly $12.50 after a 1 percentage-point increase in interest rates.

Holders of adjustable-rate mortgages are another vulnerable group, said Greg McBride, chief financial analyst at Bankrate.com, a financial-information provider that tracks interest rates.

An adjustable-rate mortgage secured in 2004 at 5 percent started adjusting a few years ago and is now at 3 percent, McBride said. That borrower "had no incentive to trade that loan in, as long as the rate was going down," he said.

"Well, now rates are going to go up," McBride said. "The reason that's a trouble spot is, those loans only reprice once per year, so you don't get a payment increase in dribs and drabs. You get it in spurts. That spells trouble for people with tight budgets."

Any benefit of higher rates for investors in money-market funds will be severely limited, said Patrick Maldari, senior fixed-income investment specialist in the New York office of Aberdeen Asset Management, a Scottish firm with its U.S. headquarters in Center City.

The average annual percentage yield on a money-market fund is 0.25 percent, or 25 basis points. As rates rise, management companies will resume charging fees to investors. They had to forgo fees just to keep the business alive while rates were so low for years.

"Best-case scenario with the Fed funds rate at 1 percent, the investor might get a money-market rate of about 50 basis points, or somewhere around that area sometime over the next year or two," Maldari said. "The average investor is not really going to be benefiting from that."

Peter Conti-Brown, an assistant professor of legal studies and business ethics at the University of Pennsylvania's Wharton School, said that formally ending the zero interest-rate policy was a big step, but just the beginning.

Indeed, although Wednesday's rate increase was telegraphed, "it is still something that businesses haven't experienced in nearly 10 years," said Tony Bedikian, managing director of global markets, at Citizens Bank. "The pace of future rate increases will be key going forward and, like the Fed, we'll be watching the data and helping our clients manage their risks in a rising rate environment."

In addition to planning further interest-rate increases, the Fed must decide what to do about its balance sheet, which has grown to more than $4.5 trillion from less than $1 trillion before the financial crisis.

No one knows for sure how to deal with the assets on that balance sheet or even what a normal Fed balance sheet looks like, said Conti-Brown, who has a book, The Power and Independence of the Federal Reserve, due out in February.

"The wild ride is not over," he said. "I think that's the thing that people should keep in mind."

The rate increase is an important step, he said, "but we don't have an understanding of what normalcy will be in the 21st century, given that so much of the 21st century so far has been spent in the midst of a harrowing financial crisis and its aftermath."

hbrubaker@phillynews.com

215-854-4651 @InqBrubaker