On February 18th, the Federal Reserve (the “Fed”) did something it has not done in quite some time – it increased interest rates, which had previously remained unchanged since the end of 2008.
The Fed raised the Discount Rate, which is the rate charged by the Federal Reserve on loans made directly to commercial banks (this temporary bank loan rate is very short-term, usually referred to as the “overnight rate”). Altering the Discount Rate does not directly change rates charged for home mortgage, credit card, auto loans, or aircraft loans. Until recently, the Discount Rate was not a common mechanism used by financial institutions who were often borrowing from other sources rather than directly from the Fed.
The Fed traditionally adjusts the discount rate and the Federal Funds Rate as economic and monetary supply conditions warrant, and for more than a year these rates have been at historically low levels. Last week, the Fed raised the discount rate by .25%; bumping it to .75%. Though this does not immediately change the rates that consumers feel, it does signal that the ‘era of extraordinarily cheap money necessitated by the crisis is drawing gradually to a close.’[1]
To us in the aircraft financing industry, this is a sign the banks are stabilizing and that the Fed can take a step back from the unprecedented involvement it has had in the financial crisis. While we do track broader market and Fed rates such as the discount rate, federal funds rate, and “Prime”, aircraft loan rates are often tied to a more complex set of underlying rates such as longer-term Treasury Bills.
Eventually, these broader market shifts will begin raising underlying interest rates, but it should be slow and controlled, and balanced with inflation. No one at the Fed wants to upset the slow improvements in the economy over inflationary worries.
[1] In Surprise Move, Fed Signals Pivot to Normal Policy. New York Times, Feb 18, 2009. Chan. http://www.nytimes.com/2010/02/19/business/19fed.html
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