The Federal Reserve Bank cut the Federal Funds Rate by 0.5% at its September board meeting, bringing the rate range between 4.75% and 5.0% and targeting a rate of 3.4% by the end of 2025. This marks the first rate cut since March 2020 and will undoubtedly serve as a benchmark for the lending market.
While a rate cut usually indicates a sluggish economy, it may bring long-awaited relief to consumers who have been eyeing the housing market. This 0.5% interest rate cut will undoubtedly create ripple effects across most of the economy, impacting consumer lending, retirement portfolios, the labor market, stock performance, and savings accounts.
Related: The average American faces one major 401(k) retirement dilemma
A 50-basis point cut will reduce the risk of a recession and likely improve consumer confidence but could increase inflation and consumer prices. Though inflation has cooled considerably from its peak of 9.1% in June 2022, it has yet to reach the Fed’s target of 2%, and consumers still feel it in their wallets.
Experts are split on whether they agree with the rate cut; a rate reduction this large is usually reserved for recessions. However, this cut is also a welcome relief from three years of aggressive rate hikes, and consumers have been waiting for it.
However, a lower interest rate will have both positive and negative implications for most facets of the economy.
Borrowers and workers can take a sigh of relief
Lower interest rates will most directly lower the cost of borrowing. This rate cut is expected to be the first of many by the end of 2025 and will greatly reduce the cost of purchasing big-ticket items such as homes and cars.
Consumer lending: Auto loans and mortgage applications will likely see an uptick, as consumers waiting out interest rates may be ready to take the plunge. However, rates are expected to continue dropping through 2025. Consumers may hold off until there is a noticeable correlation between the Federal Funds Rate cut and mortgage rates falling.
Cars are the consumer product that will be the most responsive to interest rate cuts, as there are no longer supply chain bottlenecks impacting production, and will likely see more affordable monthly payments.
Credit Card Debt: Although lower interest rates are generally a good sign for debt, credit card debt may be less impacted by these rate cuts since credit card interest rates are much higher than federal rates and are reduced less frequently.
The average credit card interest rate is over 20%, and a reduction of less than one percentage point won’t make a drastic difference in debt levels. Experts suggest those carrying debt focus on consolidating their balances at a lower rate.
More on personal finance:
- How your mortgage is key to early retirement
- Social Security benefits report confirms major changes are coming
- The average American faces one major 401(k) retirement dilemma
Labor Market: The US unemployment rate currently sits at 4.2%, and the cooling labor market appears to be top of mind for the Fed. Hiring rates and wages have both slowed, and the interest rate cut is aimed at helping improve employer and consumer confidence.
The hope is that lower interest rates make it less expensive for businesses to borrow, and encourage spending freely, improving confidence in the economy and driving down unemployment.
Mark Malek, CIO at Siebert Financial, explains how rate cuts will benefit businesses and consumers. “Though lower interest rates are typically associated with a struggling economy, a lower interest rate environment gives consumers a general feeling of confidence,” he said.
“Easier monetary conditions are considered beneficial for companies, which should ultimately strengthen the labor market. Knowing that one’s job is safe is an incredible confidence builder when it comes to purchasing large-ticket items such as homes and cars.”
Shutterstock
Inflation: This interest rate cut shows the Fed believes inflation is on its way to under control, though it has yet to reach the target of 2%. Inflation is expected to continue cooling, though consumer prices will likely remain high.
Conservative investments will see lower yields, but equities may perform well
401(k)s, investment portfolios, and savings accounts may see slower growth, but the stock market may rally following the rate cut.
Retirement and Investment Portfolios: Lower interest rates may be a double-edged sword for 401(k) plans and investments — portfolios will accrue less interest, but the stock market tends to perform well after rate cuts.
Malek explains the correlation between rate cuts, stock performance, and investor confidence. “It is well known that consumers are more confident when equity markets are rising, even if those consumers do not own stocks,” he said.
Related: Dave Ramsey explains how your mortgage is key to early retirement
“The S&P 500 has rallied in the year following the start of 5 out of the Fed’s last seven rate cutting cycles,” he explains. "If odds favor a market rally, investors will certainly benefit from rising stocks, and non-investors will become more confident.”
Equities generally perform well after rate cuts, as lower borrowing costs can improve corporate profits and investment. Bonds also tend to perform well when interest rates are cut, so existing bondholders will likely see a bump in their value.
Savings Accounts and CDs: Conservative investments such as Certificates of Deposit (CDs), money markets, and high-yield savings accounts will likely suffer as they are more directly tied to interest rates. Most fixed-income products favored by retirees, such as CDs and annuities, will see lower yields, meaning that retirees may need to monitor their portfolio allocation.
Related: Veteran fund manager sees world of pain coming for stocks
