What We’ve All Been Waiting For – Lower Interest Rates
Understandably, the U.S. Federal Reserve (the Fed) is typically not the topic du jour at your local bar or around the office watercooler. In fact, suggesting a group discussion about the Fed at your next football tailgate party would likely get you banished from future events. However, the Fed does play a substantial role within our nation’s economy which ultimately impacts our household budgets. But what exactly is the Fed’s role?
As part of its mandate, the Fed guides our nation’s monetary policy. By manipulating the cost and availability of credit, the Fed seeks to influence spending, investment, employment and inflation to promote the health of our economy. One of its main tools in this endeavor is to adjust the benchmark fed funds rate, which often serves as a basis for many types of consumer and business debt. As the fed funds rate is either raised or lowered, so typically do interest rates on credit cards, bank loans, auto loans, HELOCs and home mortgages.
Between March 2022-July 2023, the Fed raised the fed funds rate from near-0% to its current level between 5.25%-5.5%, the highest rate in 22 years. This sudden spike was in response to inflation surging to a 40-year high of 9% in June 2022. By raising interest rates, the Fed’s goal was to make it more expensive to borrow money – you’re now going to be charged a higher interest rate. As the cost of credit increases, spending inherently declines. As consumers and businesses spend less, inflationary pressures should gradually ease.
But now the Fed appears set to begin lowering interest rates. At its next meeting, scheduled for Wednesday, the Fed will likely enact its first reduction to the fed funds rate since March 2020. As you may recall, in March 2020, the Fed slashed the fed funds rate to near-0% in response to the global pandemic. On Wednesday, the consensus on Wall Street is the Fed will lower the fed funds rate by a quarter-point from its current level between 5.25%-5.5% to 5%-5.25%. The Fed is also expected to implement additional rate reductions at their subsequent November and December meetings.
So, why is the Fed now likely to begin lowering interest rates? First, the rate of inflation has significantly declined from its June 2022 peak of 9%. According to the latest Consumer Price Index, inflation now stands at 2.5%. The Fed argues that inflation should continue on a downward path to its ideal target rate of just 2%. The last time inflation was below 2% was back in February 2021 (1.7%).
Secondly, there is growing apprehension on the state of the U.S. economy. Job growth has significantly slowed over the past 12 months while the national unemployment rate has jumped to a near four-year high. Moreover, an expanding list of Fortune 500 companies have been raising alarm bells on the state of consumer spending, which drives roughly 70% of our nation’s economic growth. Many companies have begun lowering their revenue and profit forecasts for the second half of the year amid rising concerns of a recession.
The Fed’s center of attention has clearly shifted. For nearly four years, the Fed’s focus was high inflation. But now that inflation has declined to 2.5%, the Fed can shift its focus to a more pressing need – a weakening economy.
As the economy continues to weaken, the Fed wants to start lowering interest rates to ease the financial burden on consumers and businesses. The less the strain on consumers and businesses, the greater the odds the Fed can help prevent or minimize any potential recession. At least, that’s what the Fed is hoping for.
Mark M. Grywacheski, Investment Advisor
Quad Cities Investment Group is a Registered Investment Adviser.
This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Quad Cities Investment Group and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Quad Cities Investment Group unless a client service agreement is in place
