The US Federal Reserve (US Fed), under the leadership of Chair Jerome Powell, on September 18, 2024, made its first interest rate cut since 2020, lowering rates by 50 basis points (0.5%) to a range of 4.75 to 5 per cent.
The US Federal Reserve, the country’s central bank, plays a crucial role in managing the economy. One of its primary tools is interest rate policy. When the Fed lowers interest rates, it’s known as a “rate cut.” This seemingly simple action of a reduction in the key lending rate by half a percentage point can have a far-reaching impact on both the US economy and the global markets.
Jerome Powell’s Address on September 18, 2024
During the Federal Open Market Committee (FOMC) meeting on interest rate policy, on September 18, 2024, the Federal Reserve Chairman Jerome Powell outlined the central bank’s decision to cut the federal funds rate by 1/2 percentage points (50 bps). He emphasised the need to support economic growth while remaining vigilant about inflation risks.
“Inflation has eased substantially from a peak of 7 per cent to an estimated 2.2 per cent as of August. We are committed to maintaining our economy’s strength by supporting maximum employment and returning inflation to our 2 per cent goal,” said Powell during his address.
In this article further, we will understand what is US Fed Rate Cut, why it happens, and what this means for you. Let us first understand what the US Federal Funds Rate is.
What is the Federal Funds Rate?
The Federal Funds Rate is a crucial interest rate set by the Federal Open Market Committee (FOMC) of the Federal Reserve. It’s the rate at which banks lend excess reserves to each other overnight. By adjusting this rate, the FOMC can influence the overall cost of borrowing in the economy.
What is US Fed Rate Cut?
A Fed rate cut is essentially a reduction in the interest rate that the Federal Reserve charges banks to borrow money. This rate, known as the federal funds rate, serves as a benchmark for other interest rates in the economy. The Federal Open Market Committee (FOMC) decides whether to cut or raise this rate based on economic conditions such as inflation, employment, and overall economic growth. When the Fed lowers this rate, it becomes cheaper for banks to borrow money, which, in turn, can lead to lower interest rates on loans for consumers and businesses.
Why Does the Fed Cut Rates?
The Federal Reserve adjusts the federal funds rate based on economic conditions to achieve two key goals: price stability and maximum employment. These adjustments are part of the Fed’s monetary policy aimed at fostering a stable and growing economy.
The Fed typically cuts rates to stimulate economic growth. The process works like this: When the economy begins to overheat and inflation rises too quickly, the Fed may raise interest rates. Higher rates make borrowing more expensive, which can slow down spending and investment, helping to curb inflation. On the other hand, when the economy shows signs of weakening—such as rising unemployment or slowing growth—the Fed lowers interest rates to encourage borrowing and spending, thereby boosting economic activity.
In making these decisions, the Fed analyses a wide range of economic indicators, including gross domestic product (GDP), consumer spending, and industrial production. Additionally, external shocks like a financial crisis, a global pandemic, or significant geopolitical events can prompt adjustments to interest rates, as these factors can have major effects on economic stability. By responding to these signals, the Fed aims to maintain a healthy balance between growth and inflation.
Impact of a Fed Rate Cut on the Common Man
The impact of a Fed Rate Cut will influence mortgages, credit cards and saving rates for millions of people in the US – and even around the world. A Fed rate cut can have a direct impact on the common man in several ways:
- Lower Mortgage Rates: One of the most immediate effects of a rate cut is a decline in mortgage interest rates. This makes it cheaper for people to buy homes or refinance existing mortgages, which can boost homeownership rates and stimulate the housing market.
- Reduced Credit Card Interest and Personal Loans Interest: For individuals with credit card debt or personal loans, a rate cut can ease the burden by reducing the interest on these debts. This can help consumers manage their debt more effectively and increase their disposable income.
- Increased Consumer Spending: When people have more money in their pockets due to lower interest rates, they are more likely to spend. This increased consumer spending can drive economic growth and create jobs.
- Potential for Job Growth: As businesses invest and expand due to lower borrowing costs, they may need to hire more workers. This can lead to increased employment opportunities and a stronger labour market.
- Savings: On the flip side, a Fed rate cut can have a negative impact on savings accounts and other interest-bearing accounts like certificates of deposit (CDs). As interest rates fall, the returns on savings also decrease, meaning that people earn less interest on their stored funds.
Impact on the Markets
A Fed rate cut can also have a significant impact on the financial markets:
- Stock Market Rally: Investors often view rate cuts as a positive sign for the economy. This can lead to a rally in the stock market as investors become more optimistic about future economic prospects.
- Bond Prices Increase: When interest rates fall, the value of existing bonds increases. This is because the fixed interest payments on these bonds become relatively more attractive compared to new bonds with lower interest rates.
- Currency Depreciation: A rate cut can sometimes lead to a depreciation of the US dollar. This can make US exports more competitive in the global market, which can boost economic growth.
Conclusion
A Fed rate cut is a powerful tool used by the central bank to stabilise the economy during periods of economic weakness or recession. While it provides relief through lower borrowing costs for consumers and businesses, it also has implications for savings and investment patterns. Jerome Powell’s recent focus on supporting the labour market highlights the Fed’s broader goal of fostering sustainable economic growth while managing inflation. For everyday people, the benefits of a rate cut are typically seen in cheaper loans, but savers may face lower returns. Meanwhile, the financial markets often rally in anticipation of easier monetary policy, reflecting optimism about future growth.
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