What is US Fed Rate Cut? Why It Happens, and How It Affects the Common Man and Markets

The U.S. Federal Reserve (Fed), led by Chairman Jerome Powell, made its first interest rate cut since 2020 on September 18, 2024, lowering the interest rate by 50 basis points (0.5%) to a range of 4.75% to 5%.

The Federal Reserve is the central bank of the United States and plays a vital role in managing the economy. One of its main tools is interest rate policy. When the Fed lowers interest rates, it is called a “rate cut.” A seemingly simple move of cutting the benchmark lending rate by half a percentage point can have far-reaching effects on the U.S. economy and global markets.

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Jerome Powell Speech, September 18, 2024 On September 18, 2024, Federal Reserve Chairman Powell announced the central bank’s decision to cut the federal funds rate by 0.5 percentage points (50 basis points) at the Federal Open Market Committee (FOMC) interest rate policy meeting, emphasizing the need to support economic growth while remaining vigilant against inflation risks. “As of August, inflation has declined sharply from a high of 7% to an estimated 2.2%,” Powell said in his speech. “We are committed to maintaining a strong economy by supporting maximum employment and returning inflation to our 2% objective.”

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In this article, we will take a closer look at what a Fed rate cut is, why it happens, and what it means for you. Let’s first understand what the U.S. federal funds rate is.

What is the Federal Funds Rate?

The federal funds rate is an important interest rate set by the Federal Open Market Committee (FOMC) of the Federal Reserve. It is the interest rate at which banks lend excess reserves to each other overnight. By adjusting this rate, the FOMC can influence the overall cost of borrowing in the economy.

What does the Fed’s rate cut mean?

A Fed rate cut essentially reduces the interest rate the Fed charges banks to borrow money. This rate is called the federal funds rate and serves as a benchmark for other interest rates in the economy. The Federal Open Market Committee (FOMC) decides whether to lower or raise this rate based on economic conditions such as inflation, employment, and overall economic growth. When the Fed lowers this rate, it becomes less expensive for banks to borrow money, which in turn leads to lower interest rates for consumers and businesses to borrow money.

Why did the Fed cut interest rates?

The Fed adjusts the federal funds rate based on economic conditions to achieve its two key goals of price stability and maximum employment. These adjustments are part of the Fed’s monetary policy to promote stable economic growth.

The Fed typically cuts interest rates to stimulate economic growth. Here’s how it works: When the economy starts to overheat and inflation rises too quickly, the Fed may raise interest rates. Higher interest rates make borrowing more expensive, which can slow spending and investment, helping to curb inflation. On the other hand, when the economy shows signs of weakness, such as rising unemployment or slowing growth, the Fed cuts interest rates to encourage borrowing and spending, thereby stimulating economic activity.

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In making these decisions, the Fed analyzes a variety of economic indicators, including gross domestic product (GDP), consumer spending, and industrial production. In addition, external shocks such as financial crises, global epidemics, or major geopolitical events may also prompt interest rate adjustments, as these factors can have a significant impact on economic stability. By responding to these signals, the Fed aims to maintain a healthy balance between growth and inflation.

The impact of the Fed’s rate cut on ordinary people

A rate cut by the Federal Reserve will affect the mortgage, credit card, and savings rates of millions of people in the United States and around the world. A rate cut by the Federal Reserve can have a direct impact on ordinary people in a number of ways:

• Lower mortgage rates: One of the most immediate effects of rate cuts is a drop in mortgage rates. This makes it cheaper for people to buy a home or refinance an existing mortgage, which can increase homeownership rates and stimulate the housing market.
• Lower credit card and personal loan interest rates: For individuals with credit card debt or personal loans, rate cuts can reduce the interest on these debts, thereby easing the burden. This can help consumers manage debt more effectively and increase disposable income.
• Increased consumer spending: When people have more money in their pockets due to lower interest rates, they are more likely to spend. Increased consumer spending can boost economic growth and create jobs.
• Job growth potential: With lower borrowing costs, businesses invest and expand, potentially hiring more workers. This can increase job opportunities and strengthen the labor market.
• Savings: On the other hand, the Fed’s rate cuts could have a negative impact on savings accounts and other interest-bearing accounts, such as CDs. As interest rates fall, the returns on savings also fall, meaning people earn less interest on their savings.

Impact on the market

A Fed rate cut would also have a significant impact on financial markets:

• Stock market rebound: Investors often view rate cuts as a positive sign for the economy. This could lead to a stock market rebound as investors become more optimistic about future economic prospects.
• Bond price increases: When interest rates fall, the value of existing bonds rises because their fixed interest payments become relatively more attractive compared to new bonds with lower interest rates.
• Currency depreciation: Lower interest rates can sometimes lead to a depreciation of the dollar. This can make U.S. exports more competitive in global markets, boosting economic growth.

in conclusion

A Fed rate cut is a powerful tool the central bank uses to stabilize the economy during periods of weakness or recession. While it provides relief by reducing borrowing costs for consumers and businesses, it also has an impact on savings and investment patterns. Jerome Powell’s recent focus on supporting the labor market underscores the Fed’s broader goal of promoting sustainable economic growth while keeping inflation in check. For ordinary people, the benefits of rate cuts are generally reflected in cheaper loans, but savers may face lower returns. At the same time, financial markets tend to rise on expectations that monetary policy will be easier, reflecting optimism about future growth.

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Category: Optical Illusion