Hello everyone, and happy fall! As the temperatures drop, so do interest rates. Last week, the Federal Reserve announced a 0.50% (50 bps) cut to its benchmark rate. With this important decision, we wanted to take a moment to explain what it means and why it matters to you.
What is the Fed Funds Rate and Why Does it Matter?
The Fed funds rate is a cornerstone of the U.S. financial system. It’s the interest rate at which banks lend money to each other overnight to maintain their reserve requirements. While that may sound like something that only affects banks, its ripple effect is enormous. The Fed funds rate serves as a benchmark for interest rates across the economy. This includes the rates you pay on mortgages, car loans, credit cards, and the rates you earn on savings accounts. When the Fed adjusts this rate, it can influence how much borrowing costs, how much you can save, and how much consumers and businesses spend.
The Fed’s long-term goal is to promote full employment and maintain stable prices—known as its dual mandate—and uses its benchmark rate to strike that balance. When the Fed raises rates, borrowing becomes more expensive. This tends to slow down spending and investment, which is useful for controlling inflation but can also cool down the economy. On the flip side, when the Fed lowers rates, it makes borrowing cheaper and encourages both consumer and business spending, which can stimulate economic growth.
Recent Fed Rate History
Over the past few decades, the Fed has used rate changes to respond to significant economic events. From the Dot-Com bust and 9/11 (rate cuts) to the housing market boom in 2005–2006 (rate hikes) and the Great Recession (rate cuts in 2007–2008), the Fed has adjusted the rate to influence economic activity. During the COVID-19 pandemic, rates were slashed to nearly zero to support the economy through unprecedented disruptions.
In March 2022, the Fed began its most aggressive rate-hiking cycle in over 40 years to combat soaring inflation, raising rates by a total of 525 basis points (bps) through 11 rate hikes. This tightening cycle cooled inflation, which had surged during the pandemic, but also led to a slowdown in the labor market. By the summer of 2023, inflation had started to come down, and the Fed paused its rate hikes in July, holding the benchmark rate at 5.5%. *
The First Cut
After nearly two years of rate increases, the Fed took a new direction last week, cutting its benchmark rate by 0.50% at the September FOMC meeting. This was the first rate cut in the current cycle and a larger cut than many expected. Typically, the Fed reduces rates in smaller increments, like 25 bps, but this more aggressive move was driven by several factors.
First, the Fed responded to signs of slowing job creation. The labor market, which had remained relatively strong throughout the rate hikes, is now showing signs of weakness. This is a key indicator that the economy might be softening, prompting the Fed to act preemptively. Secondly, inflation has been gradually coming down, moving closer to the Fed’s 2% target. This gave the Fed more flexibility to reduce rates without reigniting inflationary pressures.
The larger rate cut also signals the Fed’s determination to support economic growth and avoid a potential downturn. While inflation is still on their radar, the Fed feels confident that price stability is within reach, allowing them to focus more on preventing further economic weakness. However, it’s important to remember that the Fed is treading carefully. Memories of the 1970s and ‘80s still loom large, when the Fed cut rates too early, only to see inflation rebound. For now, the Fed will be closely monitoring economic data to ensure it doesn't make the same mistake.
Looking Ahead
Going forward, the Fed will continue to watch inflation and employment trends. While the recent rate cut indicates a more accommodative stance, further actions will depend on how the economy evolves. If inflation keeps falling and the labor market continues to soften, we could see additional cuts. Conversely, if the economy strengthens, the Fed may hold steady to see how their previous moves play out.
It’s important to remember that the effects of rate changes often take months to show up in the broader economy. As the recent cut works its way through the system, we may see some market volatility, but this is a normal part of the economic adjustment process.
If you have any questions about how these changes might impact your financial situation or how your portfolio is positioned, please don’t hesitate to reach out. We’re here to help and are always happy to discuss your individual needs.
Chris Reaney, CFP® | Constantine Harris
Founding Partners, Managing Directors, Wealth Managers
Highwater Wealth Group
of Steward Partners
145 Maplewood Ave, Ste 100, Portsmouth, NH 03801 | 603.427.8859
chris.reaney@stewardpartners.com | constantine.harris@stewardpartners.com
highwatergroup.stewardpartners.com
*https://www.forbes.com/advisor/investing/fed-funds-rate-history/
The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates. All opinions are subject to change without notice. Neither the information provided, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results
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