Boost, Bust, or What? - The Effect of Fed Rate Cut on Consumers

In September, the Federal Reserve reduced U.S. short-term borrowing costs by half a percentage point, lowering its key rate to 4.75%-5.00%. This move comes after a series of increases aimed at combating high inflation and addressed concerns about a cooling labor market. Financial markets anticipate further rate cuts, potentially lowering the rate to around 4.00%-4.25% by the year's end, with additional reductions expected in 2025. However, policymakers do not foresee rates returning to the sub-2% levels seen before 2022, meaning low mortgage rates will likely remain elusive.

Okay, so what does that mean for consumers?

While lower rates should lead to cheaper borrowing costs and rising paychecks due to decreased inflation, consumers will still feel the impact of rising prices, especially for everyday essentials. The overall effect of these rate cuts on ordinary Americans remains to be seen.

Mortgage rates and the housing market

Image: https://www.reuters.com/graphics/USA-FED/HOUSEHOLDS/movaqeboeva/chart.png

Lower rates are expected to bring some relief to housing markets, which have undergone a period of price distortion that is pushing more people toward renting. However, the impacts won’t be evident right away.  In the wake of the pandemic’s intense disruption to housing markets nationwide, the financial strain of renting a home or obtaining a mortgage has weighed heavily on U.S. households. A mismatch between high demand and low supply has led to volatile times for renters and homeowners.

A rate cut could bring some reprieve for mortgage borrowers, but there may be a delay, in part because many lenders had already priced in a Fed cut in the near term. Further cuts are likely to take place at Fed meetings in November and December, experts said. 

Credit Cards and Car Loans

People paying off high-interest credit card debt aren’t likely to benefit as much as those seeking to avoid high mortgage rates from the Fed’s rate cut. Credit card interest rates already tend to be well above other interest rates, and companies don’t reduce them as often.

Other than mortgages, the consumer product most responsive to the Fed cut will be car loans. Lower interest rates can make them more affordable, and cars are more readily available now, so prices aren’t likely to go up much. Car dealerships should expect an increase in customers.

Interest Rates for savings

While falling interest rates will help borrowers and potentially spur economic growth, they come with a cost for savers. Historically high interest rates have benefited those with money in certain bank accounts and investment vehicles, leading to increased deposits in money-market accounts. As rates fall, funds may shift from these accounts to the stock market. Lower borrowing costs will primarily benefit younger buyers looking for homes, while retirees with high-yield certificates of deposit will see less impact. Wealthier individuals who could initially save large amounts will feel the most change as rates drop.

Inflation

The primary goal of interest rate hikes was to control inflation, but economists don't expect prices to surge again as rates fall. While prices won't return to pre-pandemic levels, their growth will likely slow to more typical rates. Prices might keep rising on certain goods or services that are affected by forces other than monetary policy, ie. homeowner’s insurance premiums affected by disasters like hurricanes, floods or fires.

IMAGE: https://www.reuters.com/graphics/USA-FED/HOUSEHOLDS/dwvkzxqqypm/chart.png

Hiring

A cooling labor market was a key reason for the Federal Reserve's rate cut. In August, Fed Chair Jerome H. Powell stated that officials do not “seek or welcome further cooling in labor market conditions.” The national unemployment rate has recently risen to 4.2 percent, and experts noted the Fed aims to prevent further weakening.

If rate cuts stimulate economic activity, it could boost business growth through increased investments and hiring. However, while the labor market remains strong by historical standards, recent signs of softening raise concerns about the Fed's pace in implementing rate reductions.

So what’s ahead?

Wait and see – future rate cuts by the Fed after September will largely depend on upcoming trends in inflation, the job market, and the presidential election's influence on consumer confidence in the weeks and months ahead.

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Sources:

• https://www.experian.com/blogs/ask-experian/fed-rate-cuts-will-take-time-to-impact-consumers/

• https://www.bcg.com/publications/2024/impact-of-interest-rate-cuts-on-consumer-spending

• https://apnews.com/article/federal-reserve-interest-rates-loans-consumers-borrowing-6127436dd3e6d8af48825aca6d3a7715

• https://www.washingtonpost.com/business/2024/09/18/fed-interest-rate-cut-mortgage-car-loans/

• https://www.reuters.com/markets/us/what-does-fed-rate-cut-mean-american-households-2024-09-18/

• https://www.investopedia.com/articles/economics/08/interest-rate-affecting-consumers.asp#:~:text=When%20the%20Fed%20cuts%20interest%20rates%2C%20consumers%20usually%20earn%20less,be%20reflected%20in%20bank%20rates.

• https://www.nbcnews.com/business/personal-finance/consumer-financial-guide-fed-rate-cut-takes-effect-rcna169629

• https://www.washingtonpost.com/business/2024/09/18/fed-interest-rate-cut-mortgage-car-loans/

• https://www.npr.org/2024/09/18/nx-s1-5115909/federal-reserve-interest-rate-cut-inflation

• https://finance.yahoo.com/news/experts-weigh-fed-interest-rate-110104433.html