Will you be better or worse off after a Fed rate cut? Find out here.
Key Takeaways
- The Federal Reserve shapes the economy by adjusting the fed funds rate, which directly affects certain borrowing costs for consumers and businesses.
- Lowering rates tends to benefit those with variable-rate loans and investors in the stock market, while savers, banks, and retirees may be negatively impacted.
- Changes in interest rates affect most consumer financial products, beginning with variable-rate credit.
The Federal Reserve will meet on Sept. 18, and experts anticipate it will cut interest rates for the first time since 2020. A Fed rate cut is good financial news for many but bad news for others.
Curious to learn who will benefit and who won’t from a Federal Reserve rate cut? Read on for more details about how a Fed rate cut works and the winners and losers of lower rates.
What Is a Fed Rate Cut?
As the country’s central bank, the Federal Reserve is responsible for guiding monetary policy, regulating the financial system, and setting short-term interest rates. The Fed’s main policy tool is its ability to adjust the fed funds rate, which is the interest rate that banks charge each other when they lend money overnight or for a few days. This rate serves as a benchmark for other interest rates paid by consumers and businesses. The Fed has left rates in a range from 5.25% to 5.50% since July 2023 after an aggressive rate-hiking campaign.
“When the economy is expanding rapidly and inflation is soaring to levels over 2%, the Fed will begin hiking rates as they did beginning in 2022,” says Dwayne Safer, associate professor of finance at Messiah University in Mechanicsburg, Pennsylvania. However, “When economic conditions are slowing and unemployment is rising, the Fed typically begins lowering rates.”
According to David Kass, clinical professor of finance at the University of Maryland–College Park, a fed funds rate cut stimulates the economy by decreasing borrowing costs for consumers and businesses. This, in turn, “can lead to more investment and consumption,” he says. “It also leads to higher stock prices since equities become more attractive relative to fixed income investments such as bonds.”
Who Wins When the Fed Cuts Interest Rates?
A Fed rate cut creates a ripple effect across various savings and loan products. Following a rate cut, interest rates on loans, including credit cards, small business loans, and student loans, tend to go down. Likewise, the interest rates banks pay on savings, certificates of deposit, and money market accounts also decrease.
Winner No. 1: Credit Card Users
If you have credit card debt, you may get some relief in the form of lower interest payments. “Consumers with credit card balances win since the interest rates for these are typically variable and tied to the prime rate – which directly corresponds to the fed funds rate,” says Sarah Alvarez, the New York City-based vice president of Mortgage Banking for William Raveis Mortgage.
The average credit card interest rate as of May 2024, according to the Fed, was 22.76%. If the Fed cuts interest rates this month by 50 basis points (0.50%), the prime rate (which credit card rates are based on) should decrease to 8.00%, which would bring the average credit card rate down to 22.26%.
Suppose that you have an outstanding credit card balance of $100,000. If so, you “would save $500 in annual interest expense due to the lower rate,” Safer says.
Winner No. 2: Borrowers
Although consumers with fixed-rate loans typically don’t benefit from a Fed rate cut, borrowers with variable-rate loans, including those with adjustable-rate mortgages or home equity lines of credit should see their monthly interest payment decrease.
For example, assume you’ve drawn $250,000 from your HELOC. At 8.5%, you’d be paying $1,771 a month (interest only). But if the Fed cuts rates by 50 basis points, your monthly payment could drop to $1,719. If the Fed cuts rates by 100 basis points, your new monthly bill would be $1,563.
Keep in mind that rates for fixed-rate mortgage loans are more closely tied to other factors including the 10-year Treasury note and investor demand for mortgage-backed securities.
“Mortgage borrowers should not expect much of a near-term decline, as mortgages are funded typically by mortgage-backed securities,” cautions Guy Silas, branch manager for Embrace Home Loans in Rockville, Maryland. “While these closely track federal funds, they are not the same and, in fact, mortgage-backed securities typically trade in anticipation of Fed actions. So if the Fed cuts rates by 0.25% as anticipated, we do not expect much change in mortgage rates.”
Winner No. 3: Investors
Historically, stock investors have been big winners when the Fed slashes rates. Robert Johnson, a finance professor at the Heider College of Business at Creighton University in Omaha, Nebraska, found that, from 1966 through 2023, the S&P 500 index returned 16.4% when the Fed lowered interest rates but only 6.2% when the Fed hiked rates.
“The best-performing sectors in a falling interest rate environment were autos, apparel, and retail. The worst-performing sectors in a falling rate environment were utilities, consumer goods, and financials,” Johnson says.
Who Loses When There Is a Fed Rate Cut?
Not everyone benefits from falling interest rates. Here’s a closer look at those who don’t fare as well.
Loser No. 1: Savers
A reduction in the fed funds rate doesn’t benefit savers, who have been enjoying yields of 5% or higher on savings accounts, certificates of deposit, and money market accounts.
Loser No. 2: Banks
Depending on their assets and liabilities, banks could be adversely impacted by a Fed rate drop.
“For example, if most of a bank’s loans are floating-rate, and the Fed cuts rates by 0.50%, the bank would see a decline in the interest income it collects on loans,” Safer notes. “This would be somewhat offset by the bank’s ability to lower the rate it pays on deposits, but not fully.”
Loser No. 3: Retirees
Retirees living on fixed incomes and relying on interest payments could feel pain when rates are cut. That’s because lower rates decrease yields, diminishing the income generated from bonds, CDs and other fixed-income instruments that retirees often invest in.
For example, “a 0.25% cut in short-term interest rates would result in a reduction of $250 per year in income from a $100,000 Treasury bill,” says Kass.
“The yield they will receive will go down in direct correlation, so a CD or savings rate will reduce accordingly,” Silas says.
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