The Federal Open Market Committee (FOMC) meeting is scheduled for September 17-18. During that time, the Fed is expected to reduce rates for the first time since March 2022.
Beginning in March of 2022, The Federal Reserve Board (“Fed”) implemented a strategy of interest rate management designed to reduce inflation and slow down our national economy. By increasing interest rates over time, the Fed believed economic performance would moderate and that we would achieve the sustainable performance ranges desired. The plan to increase interest rates, in and of itself, was not punitive. The pace of the changes implemented however became a whole other story.
Beginning with the first 25-basis point increase in March of 2022, the Fed embarked upon a rather aggressive rate increase strategy that resulted in an increase of 4.25% by the end of 2022. The Fed continued to move rates up through July of 2023, resulting in the current federal funds target rate range of 5.25%-5.50%, the highest such range in 23 years.
The higher rate environment has had wide reaching implications for both banks and their customers, with depositors seeking yield while borrowers navigate a higher cost of debt.
Since the Fed’s last hike in July of 2023, it seems there has been never-ending discussions to try and predict when it may be appropriate to reduce interest rates as the Fed attempts to balance their dual mandate of supporting maximum employment and price stability. At one point, as many as six 25-basis point rate cuts were forecasted in 2024; however, a strong labor market and resilient consumer has continued to result in the Fed leaving rates unchanged. With that said, the time appears to have finally arrived for an initial rate cut as the Fed is widely expected to reduce the target federal funds rate at the next Federal Open Market Committee (“FOMC”) meeting scheduled next week (September 17-18).
Why Now?
Support grew in anticipation of a September rate cut following the July jobs report that created increased concern around economic growth prospects. The unemployment rate increased from 4.1% to 4.3%, a low level by historical standards but one that has not been seen since October of 2021. Along with slowing inflation, this is viewed as a strong signal the Fed will begin to reduce short-term interest rates. Per the CME FedWatch tool (as of September 6th), which tracks the probabilities of changes to the federal funds rate as implied by 30-day fed funds future prices, there is currently a 57% probability of a 25-basis point rate cut and a 43% probability of a 50-basis point cut at this month’s FOMC meeting. The market is also pricing in a cumulative 110-basis point reduction by year-end with additional FOMC meetings scheduled for November and December.
How Will a Rate Cut Impact Banks and Customers?
As a result of these expected rate cuts, it is a logical question to ask how this may impact borrowing costs as well as deposit rates. While the target federal funds rate has remained in a range between 5.25% and 5.50% for more than a year, longer-term fixed rate borrowing costs, which are largely driven by the U.S. Treasury yield curve, have declined considerably in response to the anticipated rate reduction. For example, the 10-Year Treasury yield was 4.48% on July 1st and is now 3.71%, a decrease of 77 basis points. This decline is also evident in the average 30-year fixed rate mortgage, which has declined over the same period from 6.95% to 6.35% (as published in the FreddieMac Primary Mortgage Market Survey).
Borrowers with existing floating rate debt tied to a Wall Street Journal Prime or Secured Overnight Financing Rate (SOFR)-based index will likely see an immediate, or at least relatively near-term, reduction in interest if the Fed does in fact reduce rates this month. For example, borrowers with adjustable-rate mortgages that have seen their home loans reprice higher may start to see that trend reverse.
The expectation for lower short-term rates in the future has already started to influence current fixed-rate loan pricing. As a result, for those considering borrowing for either a commercial or consumer-related need, the recent pull back in rates may make available financing terms more favorable. On the other hand, like loan rates, banks may also reduce deposit pricing over the coming months in response to a Fed rate reduction, affecting products such as Certificates of Deposits as well as Money Market and traditional savings accounts. Given the impact to both banks and their customers, this month’s FOMC meeting will certainly be one of the most closely watched in recent memory.
