The Federal Reserve’s new strategy means that interest rates are likely to stay exceptionally low for a longer—a boon to people looking for work, buying a home or investing in stocks.
The central bank Thursday set aside its longtime strategy of raising interest rates when it expects inflation to start moving higher.
In practice, that means “low rates forever and a day,” said Diane Swonk, chief economist at Grant Thornton LLP.
A Closer look at the Fed Policy Change
- Fed Approves Shift on Inflation Goal, Ushering in Longer Era of Low Rates
The Fed’s new strategy won’t be welcome news to savers relying on interest income. But among the biggest beneficiaries are likely to be people seeking employment—especially low-income and minority groups that have been hardest hit by the coronavirus pandemic.
In the past, the central bank often raised rates when it thought unemployment was moving low enough to prompt strong wage increases and higher inflation. Fed Chairman Jerome Powell said Thursday the Fed would no longer automatically seek to prevent a rise in inflation and sometimes would even welcome it.
“They’re going to do everything in their power to make sure…that workers have less unemployment, greater job security, higher real wages,” said Julia Coronado, a former Fed economist and founder of economic-consulting firm MacroPolicy Perspectives LLC. “That’s what they want to achieve.”
The shift is partly a response to concerns about rising income disparities and racial inequality as well as lessons from the most recent economic expansion, when inflation didn’t pick up even as the unemployment rate plumbed 50-year lows.
Borrowing costs are already near historic lows after the Fed slashed its benchmark overnight rate to near zero in March as the coronavirus pandemic struck.
With the new strategy, rates on auto loans, credit cards and mortgages are likely to stay low.
The average rate on a 30-year fixed mortgage fell to 2.91%, mortgage finance company Freddie Mac reported Thursday, near its lowest level in almost 50 years of recordkeeping. A year ago at this time, the 30-year, fixed rate averaged 3.58%.
“This is a sea-change in the Federal Reserve’s monetary policy whose effects will be felt on home buyers for many years into the future,” said Chris Rupkey, chief financial economist at MUFG Bank. “Mortgage rates will stay close to 3% for years into the future.”
With the economy recovering slowly from a deep second-quarter contraction and unemployment above 10% in July, it could be years before the Fed gets to test its new strategy. Short-term interest rates are already near zero, meaning the central bank has little room to cut them to stimulate the economy, and much less than in past downturns.
Stocks swung up and down after Mr. Powell’s speech, and the Standard & Poor’s 500 Index ended 0.2% higher. Longer-term U.S. Treasury yields rose, a sign investors think the central bank could be successful in boosting economic growth and inflation. Yields and prices move in opposite directions.
The yield on the 30-year Treasury bond climbed jumped to 1.499%, according to Tradeweb, from 1.406% Wednesday. Long-term bond yields tend to climb with inflation expectations, because inflation erodes the purchasing power of bonds’ fixed payments. Yields rise when bond prices fall.
“The Fed has vowed to be supportive or as supportive as possible,” said Michael Lorizio, a senior trader at Manulife Investment Management. That, he said, is “going to increase the appetite for risk assets” like stocks and corporate bonds.
A risk for the Fed is that, without further guidance, longer-term bond yields could keep rising, crimping economic activity by increasing borrowing costs.
Something else for investors to consider: If the Fed succeeds in its goal of reducing unemployment to a level that allows workers to negotiate higher pay, companies might eventually have less money to return to their investors in the form of dividends and share repurchases.
“Financial markets have yet to fully digest that the Fed’s long game is to level the playing field more,” Ms. Swonk said.
—Andrew Ackerman contributed to this article.
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