What Happens When the Federal Reserve Starts Cutting Interest Rates
By Faisale Shefawe
Published on 07/22/24 4:57 PM ET
The Federal Reserve is expected to cut interest rates in September if upcoming economic reports continue to show declining inflation. According to some reports, the chance of the Federal Reserve reducing rates in two months is almost 100%. The Federal Reserve's main responsibilities are maintaining stable prices and achieving maximum employment. The Fed has been combating inflation that has persisted since the pandemic and the distribution of stimulus checks by the federal government to households and states across the country. Now, with inflation at 2.6%, the Fed is expected to lower rates from the current 5.25%-5.50% range to 5.00%-5.25%. Although the Fed's inflation target has always been 2%, they hope inflation will continue to decline in the future. If the Fed decides to cut rates, it will significantly affect the housing market, financial markets, and the banking industry.
The rate cut in September is most likely to positively impact the housing market. Prospective homebuyers who have been priced out or couldn't afford homes due to high interest rates will enter the market. Home values are highly dependent on interest rates and demand. As more people enter the housing market to purchase homes, the increased demand will drive home values to appreciate. Although it's hard to predict supply and demand in the housing market, it's more likely that there will be more buyers than sellers.
The financial market, which includes the stock and bond markets, will also be impacted in two ways by lower rates from the Fed. First, the increase in the money supply will boost spending and investments by individuals and businesses, helping the stock market to rise as expected revenue by publicly held companies increases. The stock value of companies reflects future revenue, and any forecast of revenue growth will drive stock prices up.
The second way the rate cut will affect the financial market is by lowering the demand for bonds. Investors prefer to hold bonds when rates are rising and sell when rates are falling. The main reason is that the stock market is more likely to outperform the bond market if rates are lower. Therefore, investors will reduce their bond holdings and buy more stocks to increase their rate of return.
The industry that will benefit the most from a rate cut in September is the banking industry. Financial institutions, such as banks, get a large part of their revenues from the interest rates they charge on loans. If the Fed cuts rates, more households, businesses, and investors will be encouraged to take out loans since their monthly payments will be lower. This new demand will generate billions of dollars for the banking industry, boosting their revenue and market valuations.
The most difficult question for the Federal Reserve is whether September is the right time to start cutting rates. The Fed needs to ensure they get the timing right. If they get the timing wrong and inflation starts to rise again, they will be forced to raise rates, which would damage their credibility with investors. The last thing the Fed wants to do is cut rates too quickly and lose control of inflation. So far, data suggests that September would be an ideal time to lower rates. The real estate industry, financial markets, and banks are all hoping the Fed will initiate rate cuts to boost their revenue.
