On September 18th, the Federal Reserve made a pivotal decision to implement a 50-basis-point cut, bringing the Federal Funds Rate down to a range of 4.75% to 5.00%. This move surprised many financial analysts expecting a more cautious quarter-point cut.
September’s rate cut signals a significant shift in the Fed’s monetary policy approach. After all, it’s their first rate cut in four years. Fed policymakers have also hinted at further reductions, forecasting another half-point cut by the end of 2024, followed by a full percentage point cut in 2025 and an additional half-point in 2026.
So, what motivated the Federal Reserve’s shift to rate cuts? And what does it mean for your wallet and the American economy?
Let’s break down the reasoning behind the Fed’s decision below and explore its potential impact on the stock market, the cost of credit, and several other key areas of the economy.
Why Is the Federal Reserve Cutting Rates Now?
To understand the Fed’s recent rate cut, we need to take a step back and discuss why the Fed began raising rates in 2022. Inflation was the primary driver of the Fed’s aggressive rate hikes. By mid-2022, the inflation rate had soared to 9.1%, its highest point in 40 years.
To counter rising prices, the Fed initiated a series of 11 interest rate hikes from March 2022 to July 2023. This strategy lowered the inflation rate considerably. September 2024 figures show it at 2.5%, just above the Fed’s stated target of 2%.
With inflation cooling steadily, the Fed has turned its attention to a new challenge: a weakening labor market.
The State of the September 2024 Labor Market
After falling to 3.4% in January 2023, the unemployment rate inched back above 4% this year. Though not yet an alarming figure, this uptick in unemployment raises concerns about the potential onset of a recession. Some other red flags include:
- A decrease in job openings.
- A slowdown in hiring.
- An increase in workers settling for part-time positions.
In his September 2024 statement, Federal Reserve Chairman Jerome Powell announced, “The time has come for policy to adjust.” In alignment with its dual mandate of promoting maximum employment and ensuring price stability, the Fed’s new priority is preemptively protecting the labor market while keeping a close eye on inflation. This proactive approach underscores its critical economic philosophy: the best time to protect the labor market is before layoffs and broader economic decline take hold.
How Can Rate Cuts Improve the Labor Market?
Lowering interest rates can stimulate economic activity in several ways, particularly regarding job creation. Here are a few impacts of the Fed’s rate cut on the labor market:
- Lower cost of borrowing – When the cost of borrowing decreases, businesses are more likely to take out loans to finance new ventures and hire more employees.
- Increases in consumer spending – Lower interest rates on mortgages, car loans, and credit cards can free up consumers’ budgets and give them more disposable income. The subsequent rise in consumer spending can spur business growth and lead to further job creation.
- More stock market activity – Lower interest rates can make stocks more attractive to investors than bonds or savings accounts. As stock values rise, companies may feel more confident about expanding their workforce.
As you can see, cutting rates can help create a favorable environment for businesses to expand and hire, strengthening the labor market.
How Will These Rate Cuts Impact the Rest of the Economy?
Now that we’ve covered the Fed’s motivations for lowering interest rates, let’s take a closer look at how this decision will ripple through various sectors of the economy.
#1 Returns on Investments
The impact of the Federal Reserve’s rate cut on the stock market can go one of two ways. If investors see it as a path to a soft landing, it may motivate them to increase their stock positions. However, more skittish investors may interpret the Fed’s decision as a sign of an imminent economic crash.
This initial uncertainty was evident immediately following the September 18th rate cut announcement, when U.S. equities initially rose before pulling back by the end of the day:
- The S&P 500 fell by 0.29%.
- The Dow Jones declined by 0.25%.
- The Nasdaq dropped by 0.31%.
Fortunately, the market showed signs of recovery early the next day, with the S&P 500 futures rising by 1.5%.
Long-Term Stock Market Predictions
Generally, rate cuts tend to benefit the stock market. Since lower interest rates reduce the yields of bonds and savings accounts, they often motivate more people to move their money into stocks.
Additionally, businesses can pursue growth initiatives that bolster their earning potential when they can borrow at cheaper rates. This trend is most evident in sectors sensitive to interest rates, such as real estate, technology, and consumer goods.
#2 Bonds, Savings Accounts, and Other Fixed-Income Investments
For several years, savers have enjoyed lucrative returns on their high-yield savings accounts and certificates of deposit (CDs). Savings rates peaked in September 2023, with one-year CDs averaging 1.78% APY and five-year CDs averaging 1.44% APY.
However, many banks have already begun quietly lowering their savings rates in response to the Fed’s rate cut. As more cuts are implemented, the savings rates will continue to decline, incentivizing diligent savers to switch up their strategies and place more money into stocks, real estate, and other higher-yielding investments.
Bond yields are facing a similar trajectory. While existing bonds with high rates become more valuable, new bond issuances will offer lower yields, making them less attractive for those pursuing more profitable asset allocations.
Investors may consider adjusting their allocation based on bond duration to optimize bond portfolios in this lower-rate environment. Longer-term bonds tend to benefit most from lower rates since they lock in higher yields over time.
#3 Mortgage Rates and the Housing Market
Since peaking in October 2023 at 8.45%, the average 30-year fixed mortgage rate has slowly declined, falling to 6.2% in September 2024. This reduction suggests that the Fed’s September rate cut may have been priced into mortgage rates in advance. While mortgage rates are still well above the sub-4% rates seen in 2021, the trend is positive for prospective homebuyers.
Mortgage rates are expected to continue falling gradually over the next few years. As mortgage rates draw closer to 4%, more homeowners may consider listing their homes for sale, knowing they can obtain an affordable loan on their next home purchase. This influx of inventory may quell high home prices, which have priced a substantial portion of would-be buyers out of the market.
As builder loans become more affordable, builders may also add more supply to the market in the form of new construction. This could ease the housing crunch and potentially bring down prices.
#4 Car Loans and Credit Cards
The Fed’s rate cut will also have implications for consumer credit, particularly auto loans and credit cards. Auto loan rates have remained high throughout 2024, averaging 6.84% for new cars and 12.01% for used cars. While the Fed’s rate cut may eventually bring down auto loan rates, its full effects may take time to materialize.
Credit card rates, which are tied to the Fed’s prime rate, are also at decade highs. The current average credit card interest rate is currently 24.74%. As more consumers have relied on credit cards to bridge the gap between their budget and inflation, household debt climbed to a record high of 17.8 trillion in Q2 2024.
Credit card companies tend to be slow in lowering rates, even when the Fed cuts its benchmark rate, so consumers are unlikely to enjoy immediate relief. Fortunately, borrowers can leverage other strategies to streamline their high-rate debt, including:
- Transferring credit card balances to a 0% APR balance transfer card
- Consolidating their debt with a lower-interest-rate personal loan
- Negotiating their rates and terms directly with their credit card issuers
#5 Federal and Private Student Loans
As the Fed increased interest rates, many student loan carriers took advantage of the COVID-19 student loan forbearance, a temporary relief measure implemented in March 2020 as part of the CARES Act. This forbearance period paused payments on federally held student loans, set interest rates to 0%, and suspended collections on defaulted loans through October 2023.
Many borrowers struggled to resume their student loan payments after such a long break. To add to their dismay, this year’s rate cuts are unlikely to impact federal student loans right away.
That’s because federal student loan interest rates are only adjusted once per year, on July 1. Loans disbursed after this date are facing rates as high as 6.53% for undergraduates and 8.08% for graduate and professional students.
Private student loans – particularly those with variable interest rates – are another story. Since these loans are tied to the Fed’s fund rate, the recent rate cut may lower borrowers’ interest rates and monthly payments.
Global Economic Implications: A Weaker Dollar and Export Growth
The Federal Reserve’s rate cut will likely weaken the U.S. dollar, which has already fallen against many major currencies, including the British pound and the Japanese yen.
A weaker dollar makes U.S. exports more competitive globally, potentially increasing demand for American goods abroad. This could provide a welcome boost to industries that rely heavily on international trade, such as manufacturing and agriculture.
On the other hand, a weaker dollar could increase the cost of imports, leading to higher prices for goods and services sourced from overseas, including consumer electronics, cars, and apparel.
When Will We Feel the Full Effects of This Rate Cut?
While the Fed’s rate cut is already in effect, its full impact on the broader economy will take time to materialize. Some sectors, like the stock market, may respond quickly to the changes, while others, like the housing and labor markets, will experience more gradual shifts.
It’s also important to recognize that monetary policy is just one factor that influences economic activity. Geopolitical events, global supply chain disruptions, and other macroeconomic trends may unexpectedly alter the U.S. economy’s trajectory.
Conclusion: A Fine Line for the Fed
In summary, the September 2024 rate cut marks the beginning of a new chapter. A greater emphasis is being placed on the labor market side of the Fed’s “dual mandate.” This shift will have far-reaching implications for consumers, investors, and businesses.
Over time, lower interest rates should make financing more affordable, providing potential relief for homebuyers, businesses, and borrowers with credit card debt. However, savers may see lower returns and bond investors could face challenges as yields fall.
As the Federal Reserve walks the tightrope of monetary policy, it must strike a careful balance to avoid an economic slowdown and a resurgence of inflation. In the meantime, consumers and businesses should adjust their investing and financing strategies accordingly.
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