The Federal Reserve met and voted to cut interest rates by 0.5 percentage points, the first rate cut in more than four years. If you're new to finance or not familiar with monetary policies you might be wondering 'What does this mean?' or 'How does this affect me?'. This post will help you answer your questions about the Feds' decision and the impact it will have in the coming months.
What is The Federal Reserve?
The Federal Reserve (Feds) are responsible for setting monetary policy. They control open market operations, the discount rate, and the reserve requirements. Within The Federal Reserve is The Federal Open Market Committee (FOMC) who review and determine monetary policy 8 times per year to promote economic growth. One of the goals of the FOMC is to maintain inflation rates at approximately 2%
What is the Federal Fund Rate?
The federal fund rate refers to the interest rate that banks charge other institutions for lending excess cash from their reserve balance on an overnight basis. The Feds determine the minimum percentage of deposits banks must keep in a Federal Reserve Bank (reserve requirement). Any money that exceeds this requirement is available for lending to other institutions that might be short their reserve requirement.
What does a cut in the Federal Fund Rate mean?
When the Federal Fund Rate decreases, as it did today, banks have a lower reserve requirement. When banks have a lower reserve requirement, interest rates from banks also decrease since they have more money on hand to lend to borrowers. The opposite also applies- when the Feds increase the Federal Fund Rate, banks don't have as much money to lend, and therefore increase interest rates for borrowers.
How will this positively impact me?
You can expect to see consumer debt interest rates decline in the following months. This includes credit cards, auto loans, and mortgage loans. You may have seen rates starting to drop in anticipation of the feds cutting rates, however, you still might see a slight change in rates now that it's official. If you were waiting for interest rates to drop to make a big purchase, this might be your chance!
Following the rate cuts, you might see your portfolio grow more. Lower rates means businesses can borrow at a lower cost to invest in their business leading to growth.
If you have a lot of consumer debt, this might be a good time to look at refinancing or consolidating your debt.
How will this negatively impact me?
With every postive is a negative. While many consumers will be happy with the rate cut, savers who have benefited from high rates on Certificate of Deposit (CDs) and High Yield Savings Accounts (HYSA) might see a drop in their returns.
Additionally, a rate cut weakens the US dollar, making travel outside the US more expensive.
Conclusion
The decision by the Feds to lower interest rates comes at a time when inflation is currently 2.5%, the lowest it's been since February 2021. The FOMC meets two more times this year, with the potential to lower rates again before the end of the year.
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