11 October 2024

Understanding the Impact of Federal Rate Cuts on Your Finances in 2024

The American economy is facing significant challenges in 2024, with many individuals struggling to manage their finances amid soaring prices. In response, the federal government may implement rate cuts to alleviate some burdens on consumers. This article explores the implications of these rate cuts on borrowing and investing.

Understanding the Impact of Federal Rate Cuts on Your Finances in 2024

The American economy is facing significant challenges in 2024, with many individuals struggling to manage their finances amid soaring prices, particularly for essentials like groceries. In response to these economic pressures, the federal government may implement rate cuts to alleviate some of the burdens on consumers, especially concerning their loan debts. However, while rate cuts may seem like a straightforward solution, they come with both advantages and disadvantages.

On September 18, the Federal Reserve announced a reduction in the federal funds rate by 0.5%, lowering it from 5.50% to 5.00%. This decision, along with indications of future rate cuts, signals a potential decline in short-term interest rates, according to Stephen Taddie, chief economist at HoyleCohen LLC.

Taddie explains, "The extent to which short-term interest rates will decrease is directly linked to the Federal Reserve's rate cuts. If the Fed continues its trajectory towards a 3.5% rate by the end of 2025, we can expect the U.S. Treasury yield curve to normalize, resulting in short-term rates falling below long-term rates. Consequently, the gap between money market yields and those of longer-term investments will diminish."

Bradley Thompson, CFA at New Canaan Group in partnership with Equitable Advisors, notes that lower interest rates can benefit consumers in several ways, including reduced borrowing costs for mortgages, decreased payments on variable-rate debts like credit cards, and diminished returns on certain investments such as Treasury bonds and high-yield savings accounts.

"This situation presents both positive and negative aspects," Thompson adds.

Joseph Camberato, CEO of National Business Capital, shares a generally optimistic view on the rate cuts. He acknowledges that while interest earnings on certificates of deposit (CDs) and Treasury bills may decline, the corresponding decrease in loan costs for cars, mortgages, and credit cards is a significant advantage. "Consumers and businesses have been grappling with high interest rates across various loans recently, so this shift is a welcome relief," Camberato states.

Thompson further clarifies that lowering the federal funds rate primarily influences short-term interest rates, which may lead to reduced rates for bank deposit accounts, while the impact on longer-term rates, such as the 10-year Treasury, remains less predictable.

Using car loans as an example, Camberato mentions that current rates range from 7% to 11%. "A reduction in these rates will provide much-needed relief. The savings from lower loan payments will likely outweigh the returns from investing in a CD, making it a beneficial trade-off for many individuals managing their daily finances."

However, Thompson cautions that many consumer debts, including mortgages and car loans, are linked to the 10-year Treasury or other long-term rates. Thus, a reduction in the federal funds rate may not significantly benefit mortgage borrowers. While rates have already decreased in anticipation of a lower funds rate, they do not always move in tandem.

In summary, the Federal Reserve's rate cuts typically influence the personal finances of most Americans through their effects on investing and borrowing. Taddie notes that money market yields are expected to drop by one-third by the end of 2025, while borrowers with loans tied to the Secured Overnight Financing Rate (SOFR) or other short-term benchmarks can expect similar reductions in interest expenses.

As interest rates decline, the dynamics shift, benefiting borrowers at the expense of investors, Taddie explains. "Investors and borrowers will need to adopt different strategies to navigate this changing landscape as the yield curve evolves. Lower yields on cash-equivalent investments may prompt investors to explore longer maturities, lower credit quality, or less liquid investments to maintain their income levels."

Thompson believes that despite the current high rates compared to historical standards, it remains challenging to predict the trajectory of interest rates. He advises against purchasing long-term bonds based on the expectation of further declines. However, for those with future financial obligations, such as weddings in two years, now is an opportune time to secure favorable rates. Investors with fixed-income positions in their portfolios should consider using market changes as a chance to rebalance their allocations.

In conclusion, lower interest rates on loans linked to short-term indexes can create opportunities for refinancing existing debts and fostering business growth, particularly where borrowed funds constitute a significant portion of capital investments, Taddie concludes.

Source: GOBankingRates