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October 7, 2024
On Sept. 18, the Federal Open Market Committee (FOMC) of the Federal Reserve Board of Governors (the Fed) cut the Federal Funds Rate by 0.50% or 50 basis points (bps), marking the official start of perhaps the most anticipated easing cycle in the past 30 years.
Economists and investors actively debated whether this first move would be 25 bps or 50 bps ahead of the meeting.
The Fed leaned “dovish” and reduced rates 50 bps, reinforcing their future easing intentions with the “Dot Plot,” per the commentary in their release and Chairman Jerome Powell’s press conference.
As of this writing, the markets are discounting an additional 75 bps in reductions over the remaining 2024 meetings scheduled for Nov. 7 and Dec. 18.
Perhaps more importantly, market expectations are that the Fed Funds rate will be around 3% by this time next year, or nearly another 2% lower.
The Fed’s own expectations align fairly closely with the markets for the year-out timeframe, but FOMC members only expect one or two cuts this year and more in 2025.
The Fed’s ‘dual mandate’
So, what leads the markets and the Fed to anticipate short-term rates almost 2% lower in the next year or so?
One way to think about the Fed is as a risk manager for the overall economy.
The two measures they are tasked with managing, often referred to as the Fed’s “dual mandate,” are the rate of inflation and the level of employment.
Starting in the second quarter of 2021 and running through 2023, their focus was on inflation – the Personal Consumption Expenditure Price Index (PCE), the Fed’s preferred measure of inflation, rose to 6.8% in June 2022.
Early this year, with inflation moderating and the PCE dropping to 2.6%, their focus shifted to employment.
And, though unemployment remains relatively low by historical standards, the rise in the unemployment rate from below 4% to above 4% has generated modest concern and shifted the Fed’s attention to the labor markets and the risk of a slowing economy.
With the recent 50 bps reduction in short-term rates and the signaling of further reductions in the future, the Fed hopes to engineer a “soft-landing,” or a deceleration of the economy sufficient to further reduce inflation to the long-term target of 2% without slowing it so much as to cause a recession.
This ideal outcome has several potential impacts for small-to-midsize businesses and our regional economy.
A lower rate environment where employment levels remain steady can stimulate business activity for small-to-midsize businesses that may have put expansion plans on hold due to rising inflation and economic uncertainty.
This could prompt increased hiring as businesses pursue growth and look to reap the benefits of lower rates.
Many consumers and business owners across the Midwest are savers and over the period of higher rates took advantage of the increased yields on savings instruments.
Now, with returns on those instruments expected to decrease, individuals and businesses are more likely to shift from saving to investing for growth.
One can also expect a more advantageous borrowing environment to emerge as rates continue to move down.
Though this trend could also mean a softening in the labor market, it could mean a tightening of the lending market, making access to credit more challenging.
The rate changes are one facet that influences the economy, and the unknown is how the rate changes will impact the economy in the following weeks and months.
Timing is critical
When rates are low and the economy is good, a healthy tension between low rates, high productivity and a strong economy is what to look for when deciding to take on debt.
If the rate change doesn’t impact the economy in the way the Fed desires, it can be more challenging for access to credit and borrowing in a weakening economy.
For businesses, this means many will be weighing the need for borrowing versus pursuing equity capital, which shows promising signs of being easier to access.
With the ability to access capital at much lower costs, there is again an opportunity for increasing investments back into businesses.
Whether it be investments in areas like inventory or expanded hiring, many businesses are likely to resume growth plans that may have been put on hold.
A lower rate environment also typically means a lower cost of debt.
This lower cost creates an opportunity for businesses to review any debt they are carrying and evaluate if they have the right balance between revolving and fixed debt and are able to refinance with better terms.
For the consumer, lower rates may also create opportunities.
For those who may have accumulated debt in the last few years, a more attractive environment to reduce debt or pursue more advantageous financing options may be available.
This typically leads to more willingness from the consumer to make larger purchases, for example, in new homes and cars.
We expect this to have ripple effects that will positively impact several industries.
We are still in a period of cautious optimism, and it will be essential to keep a close eye on the labor market and sentiment around job security as it is both one of the primary indicators of consumer confidence in the economy and a focus for the Fed.
Watching these trends and signals will help ensure businesses and the broader region are in a position to seize the advantages of economic growth spurred by a lower-rate environment.
The views expressed in this article are solely those of the authors and do not necessarily reflect the views of Associated Bank, N.A., its affiliates, or any other entity.
