What a Fed rate cut could mean for your wallet – Darden Report Online

Federal Reserve Chairman Jerome Powell gave a strong and clear signal for lowering interest rates on Friday at the Jackson Hole Economic Symposium, a key annual meeting of senior Fed officials. Powell noted that a change in the Fed's focus has become increasingly important to maintaining economic stability in the face of a weakening economy.

The comments follow a period in which the U.S. economy has seen steady growth while inflation has continued to decline from high levels that have caused Americans to pay more for everything from groceries to home and auto loans since the Covid-19 pandemic.

Rodney Sullivan, Executive Director of the Mayo Center of Asset Management

The Darden report asked for more context from Rodney Sullivan, executive director of the Mayo Center of Asset Management at the University of Virginia's Darden School of Business.

What Powell signals

This implies that it is time to cut interest rates. To support his point, President Powell pointed to a cooling of both inflation and the labor market over the past year. In particular, he pointed out that unemployment recently rose to 4.3%, compared to nearly 1% a year ago, while at the same time making significant progress toward the Fed's 2% inflation target. Powell further expressed his view that the economy now appears to be on a sustainable path to achieving that 2% inflation target while maintaining a strong labor market.

In his assessment, Powell concluded that upside risks to inflation had declined, while risks to economic and employment growth had increased.

Markets initially reacted positively to expectations of a more dovish Fed stance with monetary policy easing starting in September. However, there is still much uncertainty about how the US economy and interest rate cuts will impact the coming months.

What would actually be cut

If rate cuts were to occur, the Federal Reserve (Fed) would cut short-term interest rates, particularly the federal funds rate, during its next meeting in September. More rate cuts are likely to follow in the fall. This is the interest rate that commercial banks pay when they borrow and lend money to each other. It, in turn, influences the interest rates that apply to many other short-term loans. Over the past two years (2022 and 2023), the Fed has rapidly raised interest rates to contain rising inflation. As Powell suggested today, rate cuts would signal a shift in focus, better balancing the risks between inflation and rising unemployment amid growing concerns about a possible economic recession.

What impact could it have on the economy?

The federal funds rate is a key tool used by the Fed to influence economic activity, including inflation, employment, and the overall financial situation in the U.S. Lowering interest rates typically makes credit cheaper, which can encourage both consumer spending and business investment. This is good news for consumers because it likely means lower interest rates on mortgages, auto loans, and credit cards, making borrowing and spending more affordable. The Fed's goal in cutting rates would be to stimulate the economy and employment to prevent an economic recession without reigniting inflation.

What this means for markets and investments

With the economy slowing and inflation cooling, a reduction in interest rates would also likely lead to lower borrowing costs for businesses, which could boost economic growth by encouraging expansion and hiring. In addition, lower interest rates generally provide a boost to financial markets as the outlook for economic growth and corporate profitability improves. For these reasons, investors often view rate cuts as positive, as they boost stock prices and improve market sentiment.

What is the overall goal?

The Fed's job is to balance the risks between the competing goals of low inflation and maintaining full employment as best as possible. Clearly, this can be a daunting task. Even with the Fed's extensive expertise, predicting economic growth and inflation is never easy. How the economy will perform in the coming months is unclear, and the specific path to lower rates (how many rate cuts and when) will be determined by upcoming economic data. In short, the Fed is embarking on a path of easing – there remains uncertainty about the impact of any Fed rate cuts this year.