The US Federal Reserve cut its benchmark interest rate by a 0.25 interest rate point on Thursday, lowering the Fed’s rate to a range of 4.5% to 4.75% from its current 4.75% to 5% level.
This latest cut represents the second interest rate cut of 2024 and comes hot on the heels of Donald Trump’s victory in the 2024 American elections. The rate cut is seen as an anticipatory measure in preparation for what could become a more complex economic landscape when the President-elect takes office in January 2025.
What is The US Federal Interest Rate?
The US Federal interest rate is the rate at which banks lend reserve balances to each other overnight. This rate is set by the Federal Reserve and serves as a benchmark for many other interest rates in the US economy, influencing everything from mortgage rates and credit card interest to the yields on savings accounts.
Rate adjustments have historically proven to be a measure through which the US Federal reserves stimulate economic activity or cool it down, depending on the state of the economy at any given time.
By adjusting this interest rate, the Federal Reserve is able to achieve its dual mandate of promoting maximum employment and stabilizing the inflation rate.
Why Does The Federal Reserves Cut Interest Rates?
The Federal Reserves cut interest rates to stimulate economic growth in times of economic downturn and recession to stimulate economic growth. In times of slowing economic activities, the Feds cut interest rates to encourage individual and company spending while the interest rates are also cut to ensure financial institutions have enough liquidity to function optimally in times of financial crisis.
Why Does a Lower Interest Rate Matter?
When the Federal Reserve cuts interest rates, it lowers the cost of borrowing money for businesses and consumers. This encourages more spending and investment because loans for homes, cars, and business expansions become cheaper. With lower interest rates, consumers are more likely to spend rather than save, which can drive economic growth as demand for goods and services rises.
Due to a cut in interest rates and the ability of businesses to borrow at lower costs, businesses are able to invest in expanding operations, which often leads to more hiring.
This increased hiring can help reduce unemployment rates and support overall job market health. Rate cuts also provide relief to industries that need more liquidity to maintain operations and payroll.
Lower rates also tend to boost stock markets as investors shift their focus to equities as the returns on fixed-income investments like bonds decrease. This can make stocks more attractive, often leading to higher stock prices.
Rate cuts can also mean that existing bonds with higher yields become more valuable, driving up bond prices and affecting yields on newly issued bonds. A lower interest rate may also stimulate inflation as when rates are lowered, the increased money flow can push prices upward, helping inflation approach the Federal Reserve’s target (usually around 2%). This can be beneficial when inflation is too low, as it signals a healthy economy.
However, if rates stay too low for too long, it could lead to excessive inflation or asset bubbles, where the prices of assets (like housing or stocks) rise unsustainably. Interest rate cuts also mean that returns on savings accounts, certificates of deposit (CDs), and other interest-bearing accounts decrease which can be a disadvantage for those who rely on interest income, such as retirees.
How the US Federal Rate Cut Affects the Global Economy
Lower U.S. rates can prompt investors to seek higher returns abroad, boosting capital inflows into emerging markets and other economies. The reduction in interest rates also weakens the dollar’s value, thus making US goods cheaper for foreign markets, however, import becomes costlier for US residents.
Rate cuts also signal that the U.S. is taking steps to bolster economic growth, which can influence global market sentiment positively, though persistent rate cuts may also raise concerns about US economic weaknesses.
The cut in interest rates means U.S. exports become more competitive as the dollar weakens, benefiting American trade partners but potentially harming competing foreign exporters.
However, the devaluation of the dollar and the increasing American exports can cause inflation in other economies where these exports are taken to due to the influx of the dollar forcing the central banks in other countries to cut their own rates to avoid an imbalance that could affect their exports or financial stability.
