It’s not going to make much of a difference in a big banking company like U.S. Bancorp that the interest rate for federal funds is going to go up by a quarter of a point.
Rates for U.S. Bank depositors won’t shoot up Thursday. Home equity loans will still cost about what they did last week.
Yet U.S. Bank CEO Richard Davis called the long-anticipated move by the Federal Reserve to increase its key benchmark rate “remarkably important.” And when we talked Wednesday, just after Fed Chairwoman Janet Yellen’s news conference was getting underway in Washington, he sounded buoyant.
It’s easy to see why.
What it means to him is that more businesses and consumers should have the confidence to buy things and invest, and could probably use a little help from their bank to do that. That’s what the Federal Reserve just told us. It’s finally gotten around to acknowledging that the U.S. economy really has gotten much stronger.
“The American people don’t have to understand all the nuances, but they trust the Fed. I trust the Fed,” Davis said. “The symbolism of the Fed saying that after 9 ½ years, this economy, the world’s greatest economy, is now strong enough to withstand the beginning of rate rises is cathartic.”
Davis said that of course he wasn’t surprised by the Fed’s action, but added that he couldn’t be certain until the policy change was announced.
A big part of the Fed’s policy explanation was around its observation of how much the job market has improved, even though it also acknowledged a few issues, like sluggish wage growth. But since the trough of the Great Recession, the unemployment rate has about been cut in half and the Fed expects it to decline further next year. Private employers just added jobs for the 69th straight month, extending a record streak.
While that sounds great, there’s also risk that the Federal Reserve’s policy of easy money overshoots the mark and causes inflation to heat up. What’s a little odd is that late inflation has actually fallen short of the Fed’s target of 2 percent annually.
But as Yellen pointed out, acting now can make sense in that it takes a while for Federal Reserve policy changes to make much of a difference in the real economy.
Another thing that came out of her remarks is that the Fed knows it has to very gently raise interest rates further, apparently quite mindful that if rates move up too fast the Fed risks putting the brakes on economic growth.
That gentle approach is clearly the right thing to do, but it also leaves interest rates very far from normal.
Since late 2008, the benchmark federal funds rate, which is the interest rate banks charge each other for money, has been targeted to be between zero and a quarter of a percent. The federal funds rate for November was just over a tenth of a percent.
It’s hard to overstate just how weird interest rates this low have been for anybody with more than a few years’ experience in finance or banking. How can money be almost free?
If the actions the Fed announced Wednesday succeed and push this rate up a quarter percent, this benchmark interest rate will still be far lower than it’s been in the past. It got down to 1 percent after the dot-com bust recession in the early 2000s, but as recently as summer 2007 the interest rate on federal funds was around 5.25 percent.
That’s why Davis said the next time interest rate news from the Federal Reserve will really matter to borrowers and savers is after there have been enough gradual increases to have raised short-term interest rates a few percentage points.
“That’s where all of a sudden it kind of flips over,” he said. “People who are now saving money can actually, honest-to-God make money by saving, and count on it as income. And people who take out loans finally realize it’ll cost a little more than nothing.”
It will maybe take a couple of years of gradual increases in rates, he said, to get to the point where borrowers and savers start to behave like they did back before the financial crisis and Great Recession.
And maybe that’s the easiest way to characterize what just happened. It took years, but the Federal Reserve has taken the first step back to normal.