How Will The Fed’s 50bps Rate Cut Impact The Economy In Coming Months?
The Fed cut the Federal Funds Rate by 0.50% on September 18, 2024, which is not only the first rate cut since the Fed started raising rates in March 2022, but it’s also a larger rate cut than most economists predicted. The consensus going into the Fed meeting was that the Fed would cut rates by 0.25%, and they doubled it. In this article, we will cover:
How is the stock market likely to respond to this larger than anticipated rate cut?
How is this rate cut expected to impact the economy in the coming months?
Do we expect this rate cut trend to continue in the coming months?
Recession trends when the Fed begins cutting rates.
How Rate Cuts Impact The Economy
When the Fed decreases the Federal Funds Rate, it is essentially breathing oxygen back into the economy. Even the anticipation of the Fed lowering rates has an impact on the interest rate on car loans, mortgages, and commercial lending. As interest rates move lower, it usually stimulates the economy by making financing more attractive to the U.S. consumer. For example, a new homebuyer may not be able to afford a new house if it’s financed with a 30-year mortgage with a 7.5% interest rate, but as interest rates move lower, to say 6%, it lowers the monthly mortgage payments, putting the house in reach for that new homebuyer.
6 Month Delay
The reason why we support the Fed making a bigger rate cut now is the inflation rate has moved into the Feds 2% to 3% range, the job market has been cooling over the past few months, evident in the unemployment rate rising, and when the Fed cuts rates, it takes 6 to 9 months before that rate cut translates to more economic activity because it takes time for the impact of those lower interest rates to work their way through the economy.
Historically, The Fed Waits Too Long To Cut Rates
It’s reassuring to see the Fed cutting rates before we see significant pain in the U.S. economy because that is not the typical Fed pattern. Historically, the Fed waits too long to begin cutting rates, and only after a recession has arrived from rates being held high for too long does the Fed begin cutting rates. However, then there is a 6-month lag before the economy feels the benefits of those rate cuts and it’s usually an ugly 6 months for the equity market. The fact that the Fed is cutting rates now and by a larger amount than the consensus expects increases the chances that a soft landing will be delivered to the economy coming out of this rate hike cycle.
Not Out of The Woods Yet
While the Fed proactively cutting rates is a positive sign in the short term, if we look at a historic chart of the Fed Funds Rate going back to 2000, you will see a pattern from past cycles that only AFTER the Fed begins cutting rates does the economy enter a recession. So, while we applaud the Fed for being proactive with these bigger rate cuts, it still echoes the warning, “Will this rate cut and the future rate cuts be enough to avoid a recession?”. Only time will tell.
Do We Expect Additional Fed Rate Cuts
We do expect the Fed to implement additional rate cuts before the end of 2024, which if the economy hits a rough patch within the next few months, will hopefully provide some optimism that help is already on the way as these rates cuts that have already been made work their way through the economy.
The good news is they have room to cut rates by more. We were concerned at the beginning of the rate hike cycle that if they were not able to raise rates by enough, they would not have enough room to cut rates if the economy ran into a soft patch; but given the magnitude of the rate hikes between March 2022 and now, there is plenty of room to cut and restore confidence if it is needed in coming months.
COVID Stimulus Money Still In The Economy
In general, I think individuals underestimate the power of the amount of cash that was pumped into the system during COVID that was never taken out. In the 2008/2009 recession, the Federal Reserve expanded its balance sheet by about $1 trillion. During COVID they expanded the Fed balance sheet by about $4.5 Trillion, and to date they have only taken back about $1T of the initial $4.5T, so the U.S. economy has an additional $3.5T in liquidity that was not in the economy before 2020. That’s a lot of money to build a bridge to a possible soft-landing scenario.
Multiple Forces Acting On The Markets
We do expect escalated levels of volatility in the stock market in the fourth quarter. Not only do we have the market volatility surrounding the change in Fed policy, but we also have the elections in November that will inevitably inject additional volatility into the markets. As we get past the elections and enter 2025, we may return to more normal levels of volatility, because at that point the economy will know the political agenda for the next 4 years and some of the Fed rate cuts will have worked their way into the economy, potentially leading to stronger economic data in Q1 and Q2 of 2025.
All eyes will be on the race between the Fed rate cuts and the health of the economy.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
