What Does a Federal Reserve Interest Rate Cut Mean for You?

The Federal Reserve is poised to announce its first interest rate cut in four years at 2 PM on Wednesday. Economists view this moment as a pivotal change in the central bank’s battle against inflation.

The prime rate, which influences everything from mortgage rates to car loans, has remained at a two-decade high for over a year, making borrowing increasingly expensive. This anticipated rate cut is significant for the economy, although it will take time for American consumers to experience its impact.

So, what leads to the Fed’s decision to lower rates?

The Fed assesses two primary factors: inflation rates and labor market conditions. It strives to achieve what is known as its “dual mandate” – controlling inflation while keeping unemployment low.

Following the chaos caused by the pandemic, the economy faced waves of job losses, followed by substantial federal stimulus and significant supply chain disruptions. Inflation surged, peaking at 9.1% in June 2022. In response, the Fed raised rates eleven times from March 2022 until July 2023, marking the last hike.

Now, inflation has eased to 2.5%. While this figure is still above the Fed’s target of 2%, it signals a sharp decrease from its peak. Simultaneously, the labor market is showing signs of cooling. Historically low unemployment rates have risen to 4% this year for the first time since January 2022, and employers are adding fewer jobs monthly, raising concerns of a possible recession.

With recent data suggesting a slowdown in both inflation and job growth, Fed officials indicated it was time to lower rates, with chair Jerome Powell remarking in August that, “The time has come for policy to adjust. The direction of travel is clear.”

When will consumers start seeing the effects of these rate cuts?

Although the new interest rates will be effective immediately, it will take some time for their consequences to permeate through the economy. Before the official cut, the U.S. stock market reacted positively, hitting record highs in anticipation.

Anastassia Fedyk, an assistant professor of finance at UC Berkeley’s Haas School of Business, explained that while the rate changes will be instantaneous, the broader effects on consumer prices will be slower. “It takes a while to trickle through the economy,” she noted.

For instance, it has been over a year since the last rate hike, yet the ramifications are still unfolding. The inflation rate decreased to 2.5% in August from 3.7% the previous month.

While immediate changes to housing market interest rates will take time, homebuyers can expect gradual improvements. The average rate for a 30-year fixed mortgage, which peaked at 7.79% in 2023, has already fallen below 6.5%. Although this is still significantly higher than the rate seen in 2021, it indicates a new trend.

Still, existing mortgages may not see immediate benefits unless homeowners choose to refinance. “For existing mortgages, unless people are going to refinance, that’s not going to have an effect, as long as demand persists,” Fedyk added.

What about other loans? Certain loans may become more affordable, but many variables, including the borrower’s credit score, play a role. Auto loans move in line with Fed interest rates but are also influenced by individual credit histories. Credit card debt, generally one of the costliest forms of borrowing, is expected to decrease slightly too, although not by much.

Most student loans, however, will not be influenced by these rate changes as most are federally issued, with their own fixed interest rates that are detached from the Fed’s policies.

As for future cuts, the Fed typically adopts a slow and steady approach. Following the pandemic, it took eleven meetings to raise rates from 0% to 5.5%. It is likely to proceed cautiously with any reductions, potentially limiting cuts to half a point at each meeting.

Experts believe this meeting could signify the start of a new trend of rate cuts. “This Fed tends to be fairly cautious and data-driven, so it’s unlikely that this will be a one-time action,” Fedyk stated, emphasizing continued effects in the months ahead.