How Does the Federal Reserve's Recent Cut In Interest Rates Affect Your Daily Life?

In mid-September, the Federal Reserve (the Fed) cut a key interest rate by 50 basis points – also referred to as half of a percentage point – for the first time in more than four years.

Let’s examine what that means to the economy as a whole and how it may affect your daily life.

The purpose of the Federal Reserve

The Fed has a dual mandate to manage inflation and maintain full employment. Sometimes, these two economic conditions work as opposing forces.

Additionally, inflation and unemployment do not always move together, leading to one or the other of these factors to dominate economic concerns and priorities in the United States. In other words, the Fed will typically take action to either control inflation OR unemployment.

More recently, the Fed has made every effort to balance these aspects to create more gradual and controlled conditions. The Fed has two main tools at its disposal: the timing of a rate change and the magnitude of a change.

For example, raising interest rates generally helps to combat inflation, which is why interest rates have dramatically increased over the last few years. Now that inflation seems to be under control, the Fed chose to cut interest rates to maintain stable unemployment. While half of a percentage point could be considered a big move, it is important to understand that unemployment is a harder condition to affect than inflation. Moving forward, economists anticipate that interest rates will continue to go down by smaller increments as the Fed is attempting a “soft landing” that balances the economy while avoiding a recession.

What does this mean for you and your family?

The uncertainty of the pandemic years and the resulting inflation have added some pressure to family finances. The good news is that inflation has leveled off and has started to decline while unemployment is expected to remain relatively low.

As the economy finds its footing, many consumers have been hoping for an answer to rising home prices and affordability, increased interest rates for the full range of personal loans, and other economic conditions. The Fed’s most recent activity will impact these issues to varying degrees.

The current course correction mainly affects short-term loan rates, while longer-term loans like a fixed-rate mortgage will likely not change much. The interest rate cut will be more noticeable in areas such as:

• Credit card rates should go down, which means that those with credit card debt could experience some relief
• Vehicle loan interest rates could experience a mild reduction since most people finance a vehicle for 3-5 years
• Variable rate mortgages will see lower rates than in the last 18 months, making it easier for home buyers
• The Stock Market may show better returns because lower interest rates make it more attractive for businesses to borrow and invest in growth
• Shorter-term HELOCs could prove desirable as a way to finance smaller projects

The takeaway when it comes to saving versus spending will depend on the length of your financing situation. Longer-term borrowing will remain pretty stable while short-term rates are trending downward. Terms will be more favorable for those smaller purchases or variable rate loan options.

On the flip side, the Fed’s rate cut won’t solve all the world’s problems, so to speak. For example, buying a home depends on both the cost of borrowing (interest rate) and the price of any given home. Rising home prices are mostly a function of supply and demand. We are not building enough new homes at the same time that existing homeowners are choosing to stay in their homes rather than move, so home supply remains historically low compared to demand, keeping prices high.

Tips for making money decisions

Generally speaking, the recent rate cut and the expected path of interest rates over the next few months will encourage borrowing and spending. How can you make the most out of the current conditions?

• From a retirement standpoint, make sure your investment portfolio is balanced
• From a saving standpoint, consider CDs as a viable short-term investment, which may be a newer concept for younger generations
• Since short-term rates are expected to continue to trend downward, look into variable rate loan options to take advantage of any additional reductions over the next year or two
• Recognize that mortgage rates and home prices will probably not be impacted by this rate cut, so waiting won’t improve your home-buying situation much

Simply put, the Fed is trying to balance lowering inflation and promoting full employment to create a soft landing for the economy. Continued focus on this balance and the recent rate cut are positive indicators that the economy is moving in a favorable direction.

If you would like to talk to a personal banker or wealth manager about your financial goals and options for maximizing your budget, contact the Lake Ridge Bank location nearest you.