Federal Reserve Rate Reduction: How Will It Affect You?

The seal of the Federal Reserve Board as its appears outside the Fed's William McChesney Martin Building in Washington on March 13, 2023. Alex Wong/Getty Images

At the annual symposium in Jackson Hole, Wyoming, Federal Reserve Chair Jerome Powell indicated an interest-rate cut is likely at the next meeting to be held in early September. The Fed’s expected decision to cut rates could be a sign that officials feel confident that price pressures are finally coming under control.

A slowing job market is also playing a role in nudging the Fed to ease up on borrowing costs. Powell also expressed confidence in the U.S. economy’s achieving a so-called soft landing—a rare outcome in which inflation is conquered without a serious and sharp rise in unemployment. Such an achievement only happened once, in the mid-1990s.

The Federal Reserve has been maintaining higher interest rates since early 2022. The rates began to rise significantly in March 2022, when the Fed increased the federal funds rate from near zero to combat rising inflation.

Since then, the rates have continued to climb, reaching 5.33 percent as of Aug. 22, 2024. The first rate cut will be a huge deal. Just about every corner of the economy was affected as the Fed raised benchmark interest rates from around zero in early 2022 to 5.25–5.50 percent, the level it’s been since July 2023.

Rate cuts aim to stimulate economic growth, especially if the economy is slowing down. A reduction in the Federal Reserve’s interest rates can have several significant impacts on the economy.

1. Borrowing Costs

Lower interest rates reduce the cost of borrowing. This can mean increased spending on homes and cars. Credit card rates may decrease by about 1 percent. For example, if your current rate is 15.2 percent, it could drop to approximately 14.2 percent.

Rates for personal loans, auto loans, and mortgages might also see a reduction, making borrowing slightly cheaper. Lower interest rates reduce the cost of servicing debt, freeing up more money for other expenditures.While the Fed’s rates aren’t the only thing impacting mortgage rates, there is an indirect downward effect. The Federal Reserve makes short-term rate policy, while mortgages are long-term interest rate driven.

By the end of the year, mortgage lenders could be offering average rates below 6 percent on 30-year fixed-rate mortgages, according to Fannie Mae. That would be almost two percentage points lower than the highs reached in 2023.

Lower mortgage rates could help home sales rally in 2024 if buyers come off the sidelines and are drawn back into the market by more affordable financing.

Auto loan rates for new car purchases were above 7 percent in fourth quarter 2023, and higher, at 11.6 percent for used vehicles, according to Edmunds. Personal loan rates had soared due to the Fed’s hikes, and student loan rates had also increased.

2. Savings and Investments

Interest rates on savings accounts and other low-risk investments typically decrease, leaving many to seek higher-yielding, but perhaps riskier, investments such as stocks. Lower rates often lead to higher stock prices as investors seek better returns than those offered by bonds and savings accounts. It may be a good idea to lock in a higher certificate of deposit (CD) rate sooner rather than later.

Some online banks have already lowered 12-month CD rates on the expectation that rates fall in the future. High-yield savings account rates can be adjusted at any time, and banks are still advertising some of their highest rates in over a decade. But savers should expect these rates to also be lowered with the Fed rate cuts in 2024.

That means savers will likely lose some of the opportunities they’ve had to earn an easy 4 percent or 5 percent annual percentage yield (APY) without taking on risk.

3. Inflation

Lower rates can stimulate economic activity, the risk of which is reigniting inflation. It’s a delicate situation where timing is crucial. If the Fed cuts rates prematurely, it might have to reverse course and hike rates again to control inflation. On the other hand, delaying rate cuts for too long could weaken the economy significantly.

The Fed’s number-one concern is a possible rebound in inflation, especially considering that prices have already risen so much since 2021. During the 1970s, for example, the Fed started removing accommodation too soon. Inflation spiked back up. Then it had to tighten. Inflation came down. Then the Fed removed it again. Inflation went back up. And by the time the Fed was done with that, all Americans could think about was inflation.

4. Currency Value

A rate cut can weaken the U.S. dollar compared with other currencies, making U.S. exports cheaper and thus boosting America’s international trade.

Summary

Consumers may be inclined to react to lower interest rates by taking on more debt, leveraging lower rates to consolidate their higher-interest rate loans, but that isn’t generally a good reaction, at least not immediately, as rates may continue their downward trend.

“Reactionary investment actions are rarely great ones,” says David D’Eredita, founder of Rise Private Wealth Advisor. “Changes to the economic environment really shouldn’t be the catalyst for your investment changes. Changes in your own needs and time horizons should.”

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