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Lower Rates
Lower
interest rates affect investor's lives in a major way. It
was shocking to recently hear a business commentator say that
having the Federal Reserve lower the Federal Funds rate a
quarter of a percent would have no affect on anyone he knew.
Well maybe he was right if he was referring to his small circle
of friends, but if he was referring to investors, companies,
or the markets he was dead wrong. A quarter point reduction
on a $3,000 credit card balance may have little effect on
the cost of interest for an individual, but the picture is
very different when you look at large amounts. A company with
a large amount of variable rate loans can easily save thousands
or millions of dollars from even a quarter of a point reduction
in the interest rate it pays. The reduced interest cost
increases earnings. The multiplication effect is significant.
The increased earnings can be used for purchasing equipment
or giving salary increases. If the equipment is purchased,
that along with the benefit of lower rates to the equipment
manufacturer multiplies to the companies they buy goods from.
If the first company can give a larger salary increase
to an employee, keep from laying-off employees, or hire new
employees due to the interest savings, this has a multiplication
effect. The employee might go out to dinner to celebrate
the raise or being offered a new job. The restaurant they
dine at buys more supplies and if sales increase enough maybe
they contract for the kitchen remodeling project they've been
thinking about. Each of these events in turn has a multiplication
effect. A positive multiplication effect is certainly preferable
to a negative multiplication effect where earnings are reduced,
employees are cut, the equipment manufacturer cuts employees,
and the restaurant reduces their staff and orders fewer supplies.
Lower
interest rates translate into a lower prime rate, which creates
lower mortgage rates. This in turn increases the purchase
of homes and increases the number of refinances. The lower
mortgage payments put more spendable income into the pockets
of homeowners who are usually happy to spend it. When
the Federal Reserve lowers interest rates it takes 4-6 months
for it to be fully integrated into the economy. Lower interest
rates make stocks look more attractive than fixed income bonds
to more conservative investors. The anticipation of higher
corporate earnings will also work well for stock prices and
investors, lifting the value of stocks, which are frequently
valued based on expected earnings. Even further cuts in interest
rates by the Federal Reserve, as many economists predict will
occur, will create some nice results in the second half of
the year. Expect good things to come.
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