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Interest Rate Watch: Fed Cuts Interest Rates, Signals More Cuts Could Be Coming

interest rate cut

On July 31, the Federal Reserve did something it hasn’t done in more than a decade: cut interest rates. In an effort to head off the possible negative effects of a global economic slowdown and growing trade tensions between the U.S. and some of our major trading partners, the Federal Open Market Committee (FOMC) lowered its benchmark Federal Funds rate by a quarter-percentage point to a range of between 2% and 2.25%.

The rate cut — which was the first since late 2008 in the midst of the Great Recession — was widely expected by economists and investors, some of whom were disappointed that interest rates weren’t cut even more. In response, the stock market fell when the rate cut was announced, with the Dow Jones Industrial Average dropping more than 300 points that day.

Taking Preventative Measures

In cutting interest rates, the Fed hopes to prevent an economic downturn in the future by encouraging businesses to borrow and consumers to spend money, thus spurring further economic growth. Many leading economic indicators remain strong — these include GDP growth, which was up a healthy 2.1% during the second quarter, and unemployment, which at 3.7% remains near a half-century low.

However, the Fed remains concerned about slowing growth and low inflation, noting “the implications of global developments for the economic outlook as well as muted inflation pressures.” For example, growth in the manufacturing sector appears to be easing and there are fears of weaker economic growth in China and a recession in Europe. Inflation, which is viewed as a sign of healthy economic demand, remains below the Fed’s target rate of 2% at just 1.6% for the year that ended in June.

The big question now is what’s in store next for interest rates. In its policy statement issued after their meeting, the Fed indicated that rates could be cut further in the coming months given that uncertainties about the economic outlook remain. Calling this rate cut a “mid-cycle adjustment,” Fed Chairman Jerome Powell indicated that it’s “not the beginning of a long series of rate cuts.”

Some analysts believe that the Fed will pause after this initial rate cut, given the current underlying economic strength. Meanwhile, some others anticipate at least one or maybe even two more rate cuts this year, possibly as soon as the next FOMC meeting in September.

Shifting Fed Posture

The July interest rate cut is just the fifth time over the past quarter-century that the Federal Reserve has shifted from a rate-rising to a rate-cutting posture. In each prior instance, the first rate cut was followed by additional cuts later.

For example, between 1995 and 1998, the Fed made a handful of small rate reductions to help the economy avoid a recession. But between 2001 and 2007, the Fed entered a full-blown easing cycle, cutting interest rates nine times to bring the Federal Funds rate down from 5.25% to near zero by the end of 2008 before slowly starting to raise rates again in 2015.

This is when the Fed began its effort to return monetary policy to what it considered to be a more normal posture. At that time, the Fed said it expected rates to eventually settle somewhere between 3% and 4%. Last month’s rate cut marks an abrupt end to the Fed’s normalization efforts.

Effects on Household Finances

So what exactly might the rate cut mean for you? While the immediate impact will likely be negligible for most people, it could potentially affect household finances in a few ways:

  • Savings — The interest rates paid on savings instruments like money market accounts and CDs have been miniscule ever since the Fed took rates down to near zero over a decade ago — and they haven’t risen much even with the recent rate hikes. Rates paid on savings instruments probably won’t move very much in response to the rate cut, though they could trickle down if more rate cuts materialize.
  • Mortgages — The average interest rate on a 30-year fixed-rate mortgage has fallen more than a full percentage point since late last year in anticipation of rate cuts this year. Current mortgage rates have already priced in the rate cut and don’t have much further to fall when you consider that the average rate on a 30-year mortgage hasn’t fallen below 3.3% in more than a half-century.
  • Credit cards and car loans — The average credit card interest rate, which is now near 18%, also isn’t likely to fall noticeably anytime soon. The average rate on a five-year new car loan has fallen from near 5% late last year to about 4.75%, also in anticipation of the rate cut, so it too probably won’t be affected much right away.

A chief financial analyst summed up the potential effect of the rate cut on household finances this way: “The impact on the household budget of one rate cut is inconsequential.”

Please contact us if you have more questions about how interest rate cuts could affect your personal financial situation.

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