Will interest rates fall? Yes, they will.
The question is, when will it start and how can we prepare?
According to a Fortune article, analysts at Citi Research believe the Fed “could cut interest rates by 200 percentage points over eight consecutive meetings,” which would amount to eight 25 basis point cuts between September this year and July next year.
Is that possible? Absolutely. Anything is possible, but it really depends on the economics.
And we should always take these official reports with a pinch of salt. If they're wrong and the Fed doesn't cut rates, or cuts them only slowly, they can say, “Oh, the economy wasn't so bad.” If they're right and they cut rates just as quickly, they're considered geniuses.
In the prediction game, you always need to make a slightly outlandish prediction in case you're right, otherwise you'll just be an accountant (no offense, just a person who doesn't make predictions, but records exactly what happens).
When will it be defeated?
Interest rates will fall, it's just a matter of when.
What are traders thinking? Are they people placing bets in anticipation of the target rate at a future meeting?
As of early July, the likelihood of a rate cut is in the low single digits.
From the CME FedWatch tool, screenshot taken on July 8, 2024
However, looking at the September 2024 meeting, the likelihood of a rate cut to 5.00-5.25% (a 25 basis point cut) is expected to be around 75%, with a low single digit chance of a 50 basis point cut to 4.75-5.00%.
From the CME FedWatch tool, screenshot taken on July 8, 2024
The CME FedWatch tool simply reflects what the market thinks.
Federal Reserve Chairman Jerome Powell, in a number of remarks following the recent FOMC meeting, has said that interest rate cuts will come later this year, but likely towards the end of the year. If we are looking for a rate cut, the September meeting seems the most likely time for a 25-50 basis point cut.
How to prepare for interest rate cuts?
The banks are already preparing: after several meetings with no action, they have started to keep interest rates flat or slightly lower them, once at 5.25% and now at 5.00%.
5.00% has fallen to 4.90%. When banks cut interest rates, it's a signal of how far they expect rates to fall.
Unlike mortgages, which banks can sell, certificates of deposits cannot be sold. The fixed interest rate is fixed with the bank.
There will always be some volatility in interest rates as banks try to prioritize them, but most are waiting for the Fed to act.
As a consumer, I will be preparing as if September were the first month of interest rate cuts and looking at two parts of my finances: savings and loans.
1. Earn fixed interest rates on your savings
If you have short-term savings you need within the next 12 months, we recommend finding fixed deposits or other safe short-term investments that guarantee a yield. If banks are expecting interest rates to fall in September, you will likely see rates start to fall in late August/early September (as the meeting is on the 18th).
The rates aren't going to drop too quickly, so missing out on this one soon won't be a big deal.
But earning interest is better than no interest, and interest rates won't rise on short-term savings, so it's better to lock something in now.
If you need cash for the long term, you should raise it in the stock market, because the stock market loves lower interest rates. Lower interest rates mean companies can raise capital more cheaply and grow faster.
2. Prepare to refinance your loan
For loans, be careful comparing your current interest rate to yours: For most loans, a 0.25% drop won't save you enough (enough to offset the refinance fees) so you won't see much change initially.
You want to use this time to improve your credit score.
This means checking your report for errors and making sure you haven't made any mistakes on your credit score (like opening a new credit card or missing a payment) so that your score is in perfect shape when you need to refinance.
Experts recommend starting to explore refinancing options when interest rates start to fall, when you may be able to get a rate 1% or more lower than your current rate. Depending on how quickly rates are reduced, you may need to wait until rates are even lower.
If you're looking to tap into your home equity right now, take out a home equity line of credit (HELOC) rather than a home equity loan. HELOCs usually have adjustable rates, so if interest rates fall, so will your interest rate. Home equity loans usually have fixed rates.
3. Reassess your investments
I'll explain some things below, but in summary, your investment strategy should be based on you and your timeline and has nothing to do with interest rates. If you have 40 years until retirement, save early and often. If you have 10 years until retirement, you need to start planning your withdrawal strategy.
That being said, it pays to understand how interest rates affect your investments.
As we said earlier, the stock market likes lower interest rates, partly because it makes it cheaper for companies to borrow, but also because it encourages capital to flow from the bond market into the stock market.
Your intuition might suggest that if the stock market loves lower interest rates, the bond market should hate them.
Of seeds.
Existing bonds are ecstatic when interest rates fall: if they can get a 5% yield from government bonds, bonds have to pay a higher yield to get savers to lend them money. As safe yields fall, higher-yielding bonds become more valuable, increasing their value.
But new bonds will have lower yields because safe rates of return have fallen: if you can only get a 3% yield on a Treasury bond, you won't have to pay as much for the bond as you would if you were getting a 5% yield on a Treasury bond.
In a low interest rate environment, new bonds become less attractive, so investors move into the stock market.
Interest rates will fall
The Federal Reserve has set its target interest rate at 5.25% to 5.50% as of July 2024, but has indicated a desire to lower it. We know that interest rates will probably fall this year, but that is not set in stone yet.
If you start preparing now for that eventuality, you will be prepared when it happens.