Imagine driving a car with a windshield so muddy that your only choice is to look through the rearview mirror. It’s challenging to discern where you’re going solely based on where you’ve been. When judging what to do with interest rates, however, the Federal Reserve has no other choice.
The U.S. economy is looking a little bit brighter these days, compared to how it looked more than a month ago when the Fed surprised some investors and consumers with a bigger-than-expected half-point interest rate cut at its September meeting. Even so, Fed Chair Jerome Powell has teed up a smaller, quarter-point interest rate cut when the U.S. central bank’s Federal Open Market Committee (FOMC) wraps up its Nov. 6-7 rate-setting meeting.
Officials signaled that they wanted to get ahead of weakness in the labor market when they slashed borrowing costs, yet hiring has grown for four straight months and unexpectedly surged in September. A snapshot of the job market from over the summer also wasn’t as bad as it initially looked, after recent Labor Department revisions. Meanwhile, the U.S. economy grew a healthy 2.8 percent pace in the third quarter of this year, bolstered by strong consumer spending.
The Fed isn’t out of the murky, vision-impairing woods yet, either. The devastating Hurricanes Milton and Helene that ravaged parts of North Carolina and Florida, as well as a strike among factory workers at Boeing, are expected to have weighed on hiring in October — though those impacts could be temporary.
The rapidly-changing narrative — whipsawed by data that can one day look strong and other days look worrisome — illustrates just how complicated it can be to set interest rates when data is backward-looking and frequently revised. Some high-profile economists, such as Former Treasury Secretary Larry Summers, have gone as far as calling the Fed’s half-point cut “a mistake” as the incoming data started to look better.
In speeches leading up to the Fed’s meeting, officials indicated that they still think their benchmark borrowing rate is pressing the brakes too hard on the economy.
The rate cut, however, is bound to thrust them into a political spotlight they often try to avoid, given that it comes two days after Americans vote whether to elect former President Donald Trump or Vice President Kamala Harris to the White House. Contributing to the uncertainty, economists note that either candidate could mean differing economic outcomes, Trump in favor of tariffs and tax cuts and Harris supporting tax hikes for the wealthy.
The Fed is going to reduce interest rates at a much more measured pace than the increases seen in 2022 and 2023, and that means you’re not going from a high-rate environment to a low-rate environment. We’re going from a high rate environment to a not-as-high interest rate environment.
– GREG MCBRIDE, CFA, BANKRATE CHIEF FINANCIAL ANALYST
1. Should the Fed have cut interest rates by half a percentage point in September? The answer may only be known in hindsight
The decision to cut rates by half a percentage point wasn’t unanimous. Fed Governor Michelle Bowman became the first member of the Fed’s board of governors to dissent since 2005, preferring a smaller, quarter-point cut.
Minutes of the Fed’s September meeting, released three weeks after the decision, also indicate that the Fed chair persuaded officials to back the larger move. “Some participants” would’ve preferred a 25-basis point cut, those records said, and “several” noted that the smaller move would’ve helped them assess just how much to cut interest rates without risking more inflation.
“The Fed’s a lightning rod for criticism. They’re usually damned if they do, damned if they don’t,” says Ryan Sweet, chief economist at Oxford Economics. “The narrative just got too far ahead of themselves that [the job market] was beginning to fall apart, and it wasn’t.”
By going bigger in September, officials made it clear where their priorities lie: They effectively judged that the risks of doing too little outweighed the risks of cutting interest rates too much.
“You could make a case either way,” McBride says. “I’m in the camp that it was a good insurance policy. It can always cut rates less aggressively in the months ahead if need be.”
When faced with the question of whether strong job growth implies that the Fed shouldn’t have cut interest rates by as much as they did, San Francisco Fed President Mary Daly said in a mid-October speech in New York that the Fed has no evidence that stronger hiring will exacerbate inflation.
“I’m very opposed to cutting off expansion out of fear,” she said. “We should not kill off job growth and good growth as long as it doesn’t produce inflation.”
Fed officials still judge that slowing inflation is giving them the clearance to recalibrate borrowing costs. The Fed’s preferred inflation gauge — the personal consumption expenditures (PCE) index — hit 2.1 percent in September, basically reaching the Fed’s 2 percent target.
The slowdown in inflation means Fed officials might not need to choke economic growth as much. One popular way of measuring just how forcefully interest rates are slowing down the financial system involves subtracting interest rates from the current inflation rate — to get what’s called the “real” level of interest. By those measures, borrowing costs are slowing the economy down with more force today than they were back when they were at a 23-year high, Bankrate’s calculations show.
“I don’t think they have cutters’ remorse,” Sweet says. “The economy is holding up well, the job market is roughly in balance, the inflation genie is back in the bottle for the most part. They’re not going to be as aggressive as they were in September, but monetary policy is still restrictive, so it’s time for the Fed to ease their foot off the break.”
2. For now, Fed officials look like they’ll cut rates more leisurely — but that could change if the economy does
The Fed’s most recent rate projections imply two more quarter-point cuts in 2024 and four total cuts in 2025. If those moves come to fruition, the Fed’s benchmark rate would be in a 3.25-3.5 percent target range — two percentage points from their peak (5.25-5.5 percent) but still higher than at any point since the Great Recession of 2007-2009.
Those rate moves aren’t a certainty yet, though. Powell has said Fed officials will have to decide what to do with interest rates as the data — and economic picture — evolves.
“Looking forward, if the economy evolves broadly as expected, policy will move over time toward a more neutral stance,” Powell said in late September. “We are not on any preset course.”
In an October address, Fed Governor Christopher Waller walked Fed watchers through several economic scenarios and the policy response it could prompt from the Fed. If inflation continues gradually slowing and the job market holds up, Fed officials can cut rates at a “deliberate” pace. Meanwhile, if inflation slows quickly or the labor market deteriorates, Fed officials will respond by cutting interest rates more aggressively. The final scenario — if inflation heats up — would mean Fed officials can “pause rate cuts until progress resumes and uncertainty diminishes,” he said.
Dan North, senior economist at Allianz Trade North America, is skeptical that the inflation problem is fully solved. He points to corners of inflation that remain stickier. Excluding food and energy, for instance, prices edged up the most since April in the Department of Commerce’s PCE measure. Taken together, the year-over-year rate of inflation has been stuck at 2.7 percent since July.
At the same time, he also spots weakness in the labor market. The hiring rate is now the lowest since 2015, while the share of workers who’ve been unemployed for 27 weeks or more is the highest since 2017.
“The hard part for the Fed — and this is always the case — is trying to predict the future,” says Dan North, senior economist at Allianz Trade North America. “They have to look at the longer-term trends and take in as much data as possible. And what I’m seeing in the aggregate is inflation not entirely convincingly going to 2 percent and growth certainly cooling.”
Sweet’s rate-cut estimates at Oxford match the Fed’s projections, but he notes that there’s uncertainty.
“If the Fed does anything, the risks to our forecast are tilted toward fewer cuts,” he says.
3. Some interest rates have actually increased since the Fed cut interest rates
Credit cards, auto loans, home equity lines of credit and more have already started to fall across the market since the Fed’s September rate cut, according to interest rate data tracked by Bankrate. Other borrowing costs, however, have surprisingly increased.
The 30-year fixed rate mortgage has surged 68 basis points since the Fed’s half-point cut, hitting 6.88 percent in the week that ended on Oct. 30, Bankrate’s weekly national rate survey found.
That’s tied to subsequent increases in the 10-year and 2-year Treasury yields, which dictate longer-term interest rates that consumers pay more directly than the Fed. The 10-year Treasury yield is back up to the highest level since July, while the 2-year yield has surged to the highest since August.
“Some of that was the Fed’s own creation,” McBride says. “That larger half-point cut reduced the odds of a sharper economic slowdown and it increased the odds that the economy continues to grow. That threatens to slow the pace of progress on inflation.”
The elections could also be part of it, as investors react to the likelihood of either candidate contributing more to federal debts and deficits, North says. Vice President Kamala Harris’ plans could lead to almost $4 trillion in debt, while Trump’s proposals are projected to exacerbate the deficit by $8 trillion even when including revenue raised through tariffs, according to estimates from the Committee for a Responsible Federal Budget.
The behavior in the bond market might keep the Fed’s rate cut from being inflationary in the near-term, experts say, but it also might be worrisome for Fed officials who, just about a month ago, wanted to get ahead of an economic slowdown.
“That may only heighten your concern about how quickly the economy may slow in the months ahead,” McBride says.
What the Fed’s rate cut means for your money
McBride compares the Fed’s September move to taking the stairs back down to the 50th floor, after hanging around at the 55th floor for more than a year.
“The view is not a whole lot different,” McBride says. “They’re going to have to come down many more flights of stairs before the view starts to look significantly different.”
For the most part, consumers should take the same steps today in a falling-rate environment that they were taking when rates were at a 23-year high.
- Continue to chip away at high-cost debt: Credit card rates have fallen just 28 basis points since the Fed’s September rate cut, remaining near 21 percent in Bankrate data. Form a debt payoff plan and think about applying for a balance-transfer card with a 0 percent introductory annual percentage rate (APR) to help ensure that your debt repayments can make greater headway.
- Rethink any big-ticket purchases that require financing: Americans who need a car or new appliance that requires financing now might not be able to time the market. Not to mention, interest rates by the end of this year may be only marginally lower than where they are now. Yet, if you can stand to hold off on making a big-ticket purchase, it might pay to save. By the end of next year, the Fed’s benchmark rate may be two percentage points lower.
- Refinance opportunities are still there depending on when you first borrowed: The 30-year fixed-rate mortgage may now back to the highest levels since the summer, but they’re still more than a percentage point lower than a peak of 8.01 percent. A common rule of thumb is, it’s a wise idea to see how quickly you might be able to recoup the cost of refinancing if you can lock in an interest rate that’s at least half a percentage point lower than what you’re currently paying, McBride says.
- You still have time to lock in a CD: The top-yielding 1- and 2-year certificates of deposit (CDs) tracked by Bankrate have dropped more than a percentage point from their peaks, but they’re still likely to grant savers a return that’s higher than inflation until maturity. That means it’s a strong hedge against inflation to add to your portfolio, if you can afford to lock away the cash.
- Prioritize saving for the unexpected: The surge in long-term unemployment and the risks that the Fed might not get interest rates right underscore the importance of preparing for the unexpected. Experts typically recommend stashing up to six months of expenses in an emergency fund. Even better if that cash is parked in a high-yield online bank, where the funds can grow even faster.
“Cutting rates is not going to be an overnight panacea for borrowers looking to buy a car, buy a house or for some relief in the carrying costs of their existing debt,” McBride says. “This is a series of rate cuts that’s going to transpire over time, and the measurable impact will be evident only in hindsight.”
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