The Fed is poised to cut key interest rates, and the impact should be wide-ranging

By Tim Grant / Pittsburgh Post-Gazette

From the kitchen table to Wall Street, all eyes are on the Federal Reserve’s meeting this month, when a highly anticipated rate cut could turn wishful thinking into reality.

Families are hoping the Fed’s announcement on Sept. 18, will be their green light for some long-awaited home improvement projects, or that new car they’ve been pushing off until interest rates come down.

Meanwhile, on Wall Street, the anticipation for lower rates is just as intense — but with a lot more zeros attached.

“Investors believe that lower borrowing costs translate into higher profits, and that means stock prices go up,” said Paul Brahim, managing director at Wealth Enhancement Group, Downtown. “Declining rates also mean that bond prices go up. Why? Investors tend to pay more for bonds that pay a higher rate as compared to newly issued bonds with a lower rate.”

The widely predicted rate cut of at least 0.25% is expected to stimulate a sluggish housing market by reducing mortgage rates, and also to free up more disposable income for consumers with adjustable-rate loans, as their minimum payments will decrease.

For consumers in a position to pay cash and have money in the bank, the interest rate reduction won’t really matter, except when it comes to the interest they receive from savings accounts and fixed income investments they may own.

Banks also are anticipating lower rates on the horizon, and if they haven’t done it already, financial institutions will start offering lower interest on CDs and money market accounts following the Fed’s announcement.

The Federal Reserve sets the rate that banks loan money to each other overnight — the federal funds rate. Interest rates for all consumer products move in the same direction as the federal funds rate since banks loan money to consumers at a higher rate and collect a profit on the spread.

The current federal funds rate is 5.25% to 5.50%.

Right now, some online banks and credit unions are still offering 5% interest or higher for CDs and money market accounts. But that probably won’t last for long.

While four-week U.S. treasury bills still pay 5.28% interest to bond investors, longer-term treasury rates have been ratcheting down for months.

The two-year treasury bond hit 5.04% in April, but is currently paying 3.83% interest — still well above the current 2.89% rate of inflation.

Seeking a ‘soft landing’

In the aftermath of the pandemic, inflation spiked for a variety of reasons, peaking at 9.1% in June 2022.

The Fed has spent the past couple of years determined to beat inflation. Now it appears to be on track to achieve its goal of lowering inflation to 2%, and hopefully without causing a major recession.

The next few months will be critical to see whether the so-called “soft landing” approach comes to fruition, said Matthew Yanni, owner of Yanni & Associates Investment Advisors in Pine.

“The Fed definitely knows that mistakes can be made by moving too quickly or not aggressively enough,” Mr. Yanni said. “Industry experts have referred to this as the Fed’s fear of slamming into or skidding off the runway.

“The markets are forecasting the Fed to continue lowering interest rates after the September meeting,” Mr. Yanni said. “By how much and when is yet to be seen.”

Now that higher rates seem to be bringing inflation back down, the Fed is turning more attention to the issue of unemployment, said Michael Godwin, chief investment officer at Sewickley-based Fragasso Financial Advisors.

“We’ve seen an increase in the unemployment rate from 3.7% at the beginning of the year to 4.3%,” Mr. Godwin said. “The Fed is concerned about the job market continuing to weaken, thus they were hoping that cheaper money can slow or stop the upward trend in the unemployment rate.”

Relief for small business

Stock prices are expected to rise with this rate cut, but that’s not always the case.

“Is it a panic cut, or an equilibrium cut? In 2000 and 2007, the Fed made panic cuts and the equity markets fell precipitously … as economic growth fell off a cliff,” said David Root, CEO of DBR & Co., Downtown.

This cutting cycle may prove to be quite different, he said, because “the Fed is cutting rates into a healthy and stable economy.”

“The risk assets that we expect to benefit from cuts are the areas that have not participated in the rally to the same extent as large capitalization U.S. stocks,” he said.

As for “smaller companies that have been forced to tap credit markets at higher borrowing costs — lower rates will directly benefit these businesses,” he added.

Mr. Godwin also is optimistic about the boost that rate cuts could give companies with smaller capitalization.

“These are companies that generally have higher debt levels than larger ones and are more susceptible to economic stress,” he said. “This is the reason we’ve seen small and mid-cap stocks perform pretty well since a rate cut has become a near certainty.”

Impact on credit card debt

Mortgage rates are likely to keep coming down this year and next, according to Fannie Mae economists, although it will take some time for lower rates to translate into more sales.

Economists at Fannie Mae and the Mortgage Bankers Association are aligned in their view that the Fed’s rate-cutting campaign will bring the 30-year mortgage below 6% by the fourth quarter of 2025.

“As the market has fully priced in an interest rate cut in September, we’ve already seen mortgage rates move lower from over 7.5% at the beginning of the summer to currently under 7%,” Mr. Godwin said.

So much depends on the Fed’s ability to engineer a soft landing for the economy. If economic conditions weaken, consumers will defer major purchases, and rates could come down further and faster than planned.

“The same would apply to real estate,” Mr. Brahim said. “Home buyers might delay a purchase because they believe the Fed will cut rates even more. Why have a 6% mortgage when you can wait and get one for 5%?”

However, an interest rate cut of 0.25% to 0.5% won’t make much of a difference for consumers saddled with credit card debt that’s costing around 25% interest.

Consumer credit card balances have hit a staggering $1.4 trillion. Even after the federal funds rate comes down, credit cardholders won’t see an immediate impact, and it’s not likely to curb card usage.

“Individuals who hold credit card balances have been insensitive to rates,” Mr. Root said. “Those cards have served as the only lifeline for individuals to consume goods they need — food and utilities — as prices have risen faster than incomes.”