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2024 has been full of highly anticipated events. We had the total solar eclipse in April, the Summer Olympics in July, and… (drum roll, please) interest rate cuts in September. While the latter may sound much less exciting, its impact on you is potentially more significant. By now, you’ve likely seen dozens of headlines regarding the Federal Reserve (Fed) making a major policy shift by cutting rates by 50 basis points (0.50%). But what does this mean for the economy, and what does this mean for you? Let’s break down what led to this decision, and the potential short- and long-term impacts on investors.
Why is this event important?
The Federal Reserve’s role in setting interest rates is central to the U.S. economy. There are a few key areas where changing rate policy can have important implications:
- Inflation: As inflation began to rise significantly in 2022, the Fed dramatically raised interest rates to tighten spending and bring inflation back under control. Recent data indicates that inflation is now close to the Fed’s target of 2%, reducing the need for higher rates and a tighter money supply.
- Labor Markets/Unemployment: While higher interest rates successfully curbed inflation, they can negatively impact the job market by tightening employers’ budgets. With inflation under control, the Fed wants to avoid higher rates driving up unemployment. Their goal is to lower interest rates enough to maintain a strong labor market without causing inflation to rebound.
- Economic Health: The Fed faces the difficult task of ensuring the economy remains healthy and grows at a sustainable pace. Lowering interest rates often acts as an economic stimulus by encouraging easier borrowing and more spending. We don’t see this decision as a reaction to weak economic data but rather as a proactive step to balance strong economic growth, low inflation, and low unemployment.
What impacts will you see immediately?
The economic effects of lowering interest rates take time to manifest and likely won’t appear in the data for several months. However, there are a few areas where you might see immediate changes:
- Risk-Free Savings Rates: With higher interest rates, investors have enjoyed returns of 5% or more on savings vehicles like CDs, U.S. T-bills, money market funds, and high-yield savings accounts. These are closely tied to the Federal Funds Rate and will begin to decrease almost immediately in step with the Fed’s cut. That said, these rates are still substantially higher than traditional bank rates and higher than they’ve been in the past decade. While the interest you earn may decrease, we still believe it’s wise to take advantage of these vehicles.
- Borrowing/Financing Rates: As the likelihood of a Fed rate cut became more certain in recent weeks, borrowing rates began to decline in anticipation. This will soon start to ease the affordability burden for those looking to purchase cars or homes. While rates won’t drop to their 2021 lows, this will still provide relief to those seeking new auto loans, mortgages, or personal/business loans.
What are the potential future implications of lowering rates?
While some effects of lowering rates will be noticeable immediately, other impacts will take longer to materialize, particularly for investors:
- Residential Real Estate: The combination of higher mortgage rates and limited housing supply has priced many buyers out of the market. As rates decline, we expect some buyers to resume their home searches. However, rates are unlikely to return to 2021 levels, so many homeowners will likely choose to stay in their current homes longer than before.
- Opportunity in Bonds: Over the past two and a half years, rising interest rates created a challenging environment for bond market returns. As the Fed shifts toward cutting rates, this will create better opportunities in a part of the market that has been relatively muted compared to stocks.
While the Fed’s recent decision to cut rates marks a significant shift in monetary policy, its effects will take time to fully work through the economy. We anticipate a gradual and calculated decline in rates toward a neutral target rather than a rapid return to 2021 levels. As new information emerges, we’re committed to keeping our clients informed so they can make the best decisions for their unique situations.
