As you’re likely aware, the Fed cut rates for the first time in four years this September by 50bps (0.50%), bringing the Fed Funds Rate to 4.75%–5.0%, signaling a shift toward preventing an economic slowdown despite a still-solid economy. You’ve likely heard a lot about how this move is in line with market expectations, but a lot of people are wondering what actual impact this will have on their lives. Helping answer this question for you is the objective of this month’s newsletter…
For starters, the Federal Reserve (Fed) is the central bank of the United States, responsible for managing the country’s monetary policy. The two primary objectives of the Fed, its ‘dual mandate’, is to promote maximum employment and stabilize prices (inflation control). One of the primary tools the Fed uses to influence the economy is adjusting the federal funds rate.
What Does a Rate Cut Mean? When the Fed cuts the federal funds rate, it makes borrowing cheaper for banks. In turn, banks lower the interest rates on short-term loans to businesses and consumers, making it more affordable for people and companies to borrow money.
How Does It Impact the Economy and Everyday Investors?
- Consumer Spending: With lower interest rates, mortgages, car loans, and personal loans become cheaper. This can encourage consumers to borrow and spend more, boosting economic activity.
- Business Investment: Companies can borrow at lower rates to finance expansion, buy equipment, or invest in other growth opportunities, spurring business investment and economic growth.
- Housing Market: Lower mortgage rates can make homeownership more accessible, often leading to an uptick in home sales and refinancing activity.
- Stock Market: Lower interest rates generally make stocks more attractive compared to bonds, as bond yields typically fall. Investors may shift into equities, potentially driving up stock prices.
- Inflation: The downside of rate cuts is that they can contribute to inflationary pressures. With more money circulating in the economy and higher demand for goods and services, prices can rise. The Fed monitors this closely and will typically raise rates again if inflation becomes a concern.
- Savings and Fixed-Income Investments: On the flip side, lower interest rates can hurt savers, as the returns on savings accounts and fixed-income investments (like bonds and High Yield Savings Accounts) decrease. Retirees and conservative investors may find it harder to generate income from these traditional sources.
What’s next?
- Beyond the reduction in interest rates, the Fed released a new Summary of Economic Projections, or “Dot Plot,” which points to another 50bps move lower in rates by year end and another 100bps move lower across 2025 (all in 25bps increments), which would bring the Fed Funds Rate to a range of 3.25% to 3.50% by 2026. This is an indication that the Fed feels the battle against inflation has been won and the battle to prevent an economic slowdown from turning into a recession must be joined.
- The impact on the stock market depends on the reason for the cut.
- If rates are cut to avoid or mitigate a recession, stock prices may suffer; however, if the economy is still growing and inflation is moderating, rate cuts can support stock prices.
- Since 1970, the S&P 500 has risen 5 out of 8 times six months after rate cuts during meaningful economic inflection points, offering a positive outlook if the economy remains stable.
As the Fed’s recent rate cut trickles through the economy, it’s essential to understand how these changes could impact your personal financial plan. Whether it’s rebalancing your portfolio to take advantage of potential stock market shifts, exploring opportunities to refinance high-interest debt, or evaluating your overall investment strategy in light of lower bond yields, now is a great time to review your financial situation.
At Bowline Financial, we’re here to help you navigate these changes and ensure your plan is optimized for today’s economic environment. If you’re curious about how this rate cut affects your household’s financial outlook, reach out to us for a personalized review.