While the Federal Reserve kept interest rates unchanged on Wednesday, a change in tone is taking place and there is a possibility that the first rate cut in four years could be announced in March.
Officials at the rate-setting Federal Open Market Committee (FOMC) removed one sentence from their statement on the possibility of higher rates, which represents a significant step as the Fed changes its stance on future rate actions.
However, the committee says it does not plan to cut rates “until it has gained greater confidence that inflation is moving sustainably towards 2%.”
The first rate cut will be a big deal. Nearly every corner of the economy has been affected by the Fed raising benchmark interest rates from around zero in early 2022 to 5.25%-5.50%, the level it has been since July 2023. Inflation fell, which was the main reason the Fed raised rates. For starters, as borrowing costs rose, the housing market slowed and bond yields rose.
If and when rates are finally cut, many of the trends of the last two years will begin to reverse. To some extent, this is already happening, precisely in anticipation of rate cuts.
Mortgage rates will fall
While Fed rates aren’t the only thing that influences mortgage rates, they’re probably more influential than anything else. Interest rate cuts by the Fed typically put downward pressure on mortgage rates.
Mortgage lenders could offer average rates below 6% on 30-year fixed-rate mortgages by the end of the year, according to Fannie Mae. This would be almost 2 percentage points less than the highs reached in 2023.
Lower mortgage rates could help home sales rally in 2024 if buyers move away and return to the market thanks to cheaper financing.
Likewise, homeowners with pre-2022 low-rate mortgages would not feel as “stuck” on their loans and may decide it is finally the right time to put their home up for sale, easing market woes with a inventory shortage.
Savings rates won’t be as high
In a high-interest rate environment, banks and other financial institutions improve rates on products such as high-yield savings accounts and certificates of deposit (CDs). These rates would fall along with rate cuts by the Fed.
Some online banks have already lowered 12-month CD rates in hopes that rates will fall in the next year.
High-yield savings account rates can be adjusted at any time, and banks continue to advertise some of the highest rates in a decade. But savers should expect these rates to also be lowered in tandem with any Fed rate cuts in 2024.
This means that savers will likely miss out on some of the opportunities they had to earn an easy 4% or 5% APY without taking on any risk.
Rates for auto loans, personal loans and more will decrease
According to Edmunds, auto loan rates for new car purchases were above 7% in the fourth quarter of 2023 and even higher, 11.6%, for used vehicle purchases. Personal loan rates have soared due to the Fed hikes, just as student loan rates have also increased, especially for private loans. Credit card APRs are always high, but banks have also increased them with the Fed hike.
On the contrary, if rates are cut in the coming months, we are likely to see a change: rates should fall for all these products, giving consumers access to cheaper financing. Falling rates would also give consumers the opportunity to refinance mortgages and other existing loans and save money on monthly payments.
Inflation could rise again
A major inflation indicator watched by the Fed that tracks core prices shows a rate of 2.9% over the past 12 months. This is a notable improvement from the peak of 5.6% seen in early 2022, and on a six-month basis, core inflation is actually slightly below the Fed’s target inflation rate of 2%.
This decrease in the inflation rate paves the way for the Fed to cut rates, but there is always the risk of cutting too soon. If rate cuts open the door to spending, prices could rise faster than the Fed wants.
For example, Americans who are waiting for the opportunity to find good financing for a major purchase like a car may be motivated to start shopping, resulting in increased demand and potentially higher prices.
The Fed’s No. 1 concern is a possible rebound in inflation, especially considering that prices have already risen so much since 2021.
Because of these risks, the FOMC may decide to postpone rate cuts into the early part of 2024 while continuing to monitor the situation to make sure inflation is under control.
Rate cuts should help the stock market
Given the discounted expectations of rate cuts and the strong performance of stocks of late, it is difficult to predict how investors would react to an interest rate cut by the Fed in March.
Over the long term, however, if the Fed cuts rates faster than the market expects, there will likely be upward pressure on stock prices.
Interest rates affect the stock market in many ways, but, in general, companies are better off when they can borrow money cheaply and when consumers can spend more freely. For similar reasons, when interest rates are low, you also tend to see higher GDP growth and more hiring.
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