Why is a 25 basis-point rate cut by the Federal Reserve so important? It is a question I often hear these days as I speak about the economy around the country.
The truth is that for most Americans, a quarter-point rate cut is not that important. At best, consumers get a modicum of relief on the average 21.1% variable interest rate they are paying on their credit cards while their rates on auto and home loans fall by a few basis points.
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So even though those payments become a little less expensive, that answer does not adequately explain the sound and fury that has accompanied the debate over whether the Fed should cut its policy rate on Sept. 17.
So why is that?
On Wall Street, low rates, liquidity and leverage are the holy trinity of new finance.
Those low rates create conditions at the front end of the curve that result in rising liquidity, which then permits those who work in modern finance to increase leverage to chase higher returns across asset markets.
On Wall Street, money matters and credit counts. Low rates spur risk taking through higher leverage, which then stokes credit-fueled expansions that redound to the favor of those who work in modern finance.
Lower rates at the front end of the Treasury curve support greater risk taking—hopefully based upon well-hedged risk—which generates outsized returns and in turn drives asset prices higher.
So, when the Fed reduces the federal funds policy rate at its meeting on Wednesday, remember that the realities of Main Street are quite different from those on Wall Street.
