The US Federal Reserve (Fed) cut short-term interest rates another quarter of a point on Thursday.
With the election over, stock prices soaring and interest rates falling, there is a bubbly sense of optimism in the capital markets.
Inflation in September was 2.4%, just a fraction of the 2% target, prompting Fed officials to cut interest rates by another 0.25%. The challenge of giving the economy a soft landing remains.
There are a lot of moving parts to adjust.
Read more: Fed's 2024 predictions: What experts say about the possibility of further rate cuts
The Fed controls one interest rate. It's the federal funds rate, the short-term interest rate that banks use to borrow from each other. The target range for the federal funds rate is currently 4.50% to 4.75%.
The Fed's interest rate decisions pass through the financial world and affect virtually every aspect of borrowing costs and savings rates. Interest rate management is a financial drug used by the Fed to:
It slows down the economy by raising interest rates to reduce rising costs (high inflation) as measured by the consumer price index.
By lowering interest rates as an injection of liquidity into the financial system, we help accelerate recovery when we are on the other side of the economic cycle.
Let past movements settle while the Fed considers future actions by keeping interest rates on hold.
“As the economy develops, monetary policy will be adjusted to best advance our goals of maximum employment and price stability,” Fed Chairman Jerome Powell said at a press conference on Nov. 7.
He reiterated that the FOMC makes decisions on a meeting-by-meeting basis and can adjust monetary policy as circumstances warrant.
“Policy restraint can be tapered more slowly if the economy remains strong and inflation is not moving sustainably towards 2%. If the labor market weakens unexpectedly or if inflation If it drops faster than expected, we can act more quickly,” Powell said.
See how the Fed's new interest rate strategy affects your loans and accounts.
Short-term liquidity depends on money in banks. As interest rates rose, so did deposit rates.
This time, the income from cash deposited in banks begins to decline. As providers begin to ease interest payments, smart savers will need to look for the best returns.
With a checking account that pays interest, you will only earn a small profit. But if you need quick access to your funds and manage your cash flow, banks won't have most of that money in their hands for long.
As of October 2023, interest-bearing checking account payments averaged 0.07% per month nationwide. One year later, that interest rate remained unchanged at 0.07%. This is already slightly lower than the 0.08% interest paid in September this year.
It's best to keep your short- to medium-term money in a savings account. This is part of an easy-in, easy-out cash strategy. As of October last year, the average monthly interest rate on traditional savings accounts at brick-and-mortar banks was 0.46%. Last month it was 0.45%.
Higher-yield savings accounts pay more. Yahoo Finance sees APYs for high-yield savings accounts ranging from 4.00% to 5.25%. You can see that shopping fees are actually paying off. (APY is the result of compounding interest. Compounding periods may vary by bank.)
Money market accounts often increase your returns from regular checking accounts, but you may need to deposit $10,000 to $100,000 to get the increase.
The national average monthly interest rate in October last year was 0.65%. After one year, it will be 0.61%. Consider putting your second cash in an above-average money market account. It's money you want to keep on hand, but it's not closing your checking account.
To do this, look for a high-yield money market account. As the Federal Reserve continues to lower interest rates, high-yield money market accounts will begin to pay less. Yahoo Finance expects a high-yield interest rate of 4.00% to 5.25%.
What to do now: Shop for bank rates both in-store and online. Keep your short-term cash agile and get the best rate possible.
This new low interest rate cycle will also impact CDs.
The 12-month CD was earning 1.79% monthly interest as of October 2023. One year later, CDs were paying 1.81% during the same period. But these national averages don't always reflect the better rates you can find if you shop around. The best CDs are around 4.50-4.85% APY for a 6-month term. Minimum deposit amount and duration will affect the rate.
What to do now: Use CDs to earn interest on your medium-term funds. As interest rates fall, long-term CDs may be your best option while using other easily accessible solutions for short-term savings.
Now we move to the other side of the asset/liability ledger. In this case, lower interest rates work in your favor.
Interest rates on personal loans rose from 8.73% at the start of the Fed rate hike in 2022 to 12.33% in August 2024, according to the latest data available. Now that the Fed is lowering interest rates, these rates are expected to decline over time.
Most federal loans have fixed interest rates, so Fed policy has no effect. Private student loans may have variable interest rates, and Fed rate hikes may be a factor.
To find out the interest rate on your existing loan, contact your lender or loan servicer.
If you've been looking to buy a home in the past two years, you probably know this story. Mortgage interest rates have skyrocketed. According to Freddie Mac, lenders were pricing 30-year fixed-rate mortgages at around 4% when the Fed's interest rate hikes began.
Mortgage rates for 30-year fixed mortgages fell below 7% last December, after rising to nearly 8% last fall. Apart from a rise of more than 7% in May, mortgage interest rates have remained in the 6% range.
It took nearly 20 years for mortgage rates to fall from 7% in 2001 to less than 3% annually in 2020. And homebuyers may not see financial institutions set mortgage rates that low again anytime soon. The 50-year average for a 30-year fixed-rate mortgage is still well above 7%.
What to do now: As borrowing costs gradually decline, resist the urge to take on more debt or extend the term of your existing loan. Monitor upcoming mortgage refinance opportunities.
Read more: How the Fed's interest rate decisions affect mortgage rates
Credit card interest rates rose from an average of just over 16% to well over 21% during the Federal Reserve's rate hike cycle. With the move to lower interest rates, you can expect to see some reduction in fees on credit card balances.
But that peace comes gradually.
What to do now: Lower interest rates will help you reduce your credit card debt faster. Prioritize paying off your available credit cards, especially those with the highest interest rates, and consider transferring your balance to a lower-interest or no-interest credit card as your credit score allows. If you have good credit, a personal loan for credit card debt consolidation may be an option to consider.
The Federal Reserve System was created in response to the banking crisis of 1907. Today, the Federal Reserve is the glue that holds our diverse financial system together. The Fed's interest rate moves are being closely watched on Wall Street and can provoke swift reactions within the capital markets.
Dig deeper: The stock market crash that triggered the Fed
inflation and the job market
The Fed is trying to keep inflation in check by moving interest rates with the goal of minimizing the impact on the job market. Adjustments in consumer demand cause consumer prices to rise or fall.
Read more: Employment, inflation, and the Fed: How they all relate
401(k)s, IRAs, and taxable investments
How does all this affect your investments?Some people avoid looking at their 401(k) during significant market declines. Some people are obsessed with daily income and expenditure.
Perhaps something in between these two extremes is best. Perform regular maintenance under the guidance of a specialist as necessary.
When the Fed lowers interest rates, companies have access to cheaper capital. This drives business expansion, employment, and often stock price performance. However, stock prices in the banking and financial services industries could fall due to profit pressure as profit margins shrink.
That's why the right mix of investments, known as asset allocation, can help reduce risk.
Read more: When the Fed lowers interest rates, how does it affect stock prices?
