Fed announces sharp interest rate cut, first since 2020

The Federal Reserve cut interest rates by an unusually large half-percentage point on Wednesday and signaled that further cuts were on the way for households struggling with persistently high prices and a broader economic slowdown.

This is the first rate cut since 2020 and reflects a shift in policymakers’ primary focus from fighting inflation to preventing a deterioration in the labor market.

While inflation has fallen, job growth has slowed significantly in recent months. The U.S. unemployment rate has fallen from 3.7 percent at the beginning of the year to a record low of 4.2 percent. The latest unemployment figure for California is one percent higher.

“This adjustment in our monetary policy will help maintain the strength of the economy and the labor market, and will continue to enable further progress on inflation,” Fed Chairman Jerome H. Powell said at a news conference after the conclusion of a two-day policy meeting on Wednesday.

Stocks have been trading higher in recent days, initially climbing on news of the Fed’s aggressive rate cut, but then gave up their gains to end slightly lower on Wednesday.

While lower interest rates should ultimately help in many areas, from credit card fees to home purchases, analysts caution that it could take months for those benefits to trickle down to consumers because many transactions associated with interest rates take time to occur and reverberate through the economy.

“Consumers won’t get a windfall financially. Rather, it will take six to 12 months before they see any meaningful relief in terms of interest and monthly payments,” said Greg McBride, chief financial analyst at Bankrate.com.

Learn more:California is an economic powerhouse. Why are its residents suffering the most from high interest rates?

The impacts could be greater in California than in many other states: California’s economy is very sensitive to interest rates, particularly in the housing and small business sectors.

“This should help us pay down our loans,” said Teghvir Toor, who runs a family-owned Arby’s franchise in Sacramento. “The real effects of this decline won’t be felt for several months, so I’m hoping it will improve our customers’ purchasing power, which will hopefully translate into more discretionary spending.”

While the Fed has little doubt about its willingness to cut borrowing costs, with inflation clearly slowing, it is unclear whether policymakers will take more or less significant action. Many market participants and analysts called for a half-point rate cut rather than the more conventional quarter-point cut on Wednesday, arguing that the central bank has kept interest rates too high for too long, restricting business activity and straining consumers, particularly young, middle-income households whose debt and default rates have risen significantly.

Many analysts, however, expected the Fed to take a cautious stance, not wanting to risk reigniting inflation or giving the impression that the labor market and economy are in trouble and need immediate support. Of the 12 voting members of the Fed’s policy-making committee, only one favored a quarter-point cut.

With Wednesday’s action, the Fed’s benchmark interest rate will be between 4.75% and 5%, still the highest since 2007.

Powell said the Fed was not trying to catch up by cutting rates more than expected. “We don’t think we’re behind,” he said, repeatedly saying the job market and the broader economy are doing well.

“And our intention, with our political decision today, is to maintain this level,” he said.

Fed officials, in their economic projections released Wednesday, generally expect the U.S. economy to grow at a solid 2% pace this year and through 2027. They expect unemployment to rise slightly to 4.4% by December and inflation to end the year at 2.3%.

The Fed’s benchmark overnight rate influences a range of business and consumer loans. In recent weeks, market expectations of a Fed rate cut had already pushed down home loan rates. The average rate on a 30-year fixed-rate mortgage was 6.2% last week, down from 6.73% in early August and 7.18% a year ago, according to Freddie Mac.

Other borrowing rates, including averages for credit cards, auto loans and home equity lines of credit, all at record lows in more than two decades, have changed little recently and are expected to decline only gradually.

According to the latest projections from Fed officials, the central bank is expected to cut interest rates by a quarter-point two more times this year and four more times next year. Powell, however, cautioned that interest rate policy is not following a predefined course and that future decisions will depend on incoming economic data.

In early 2020, before the COVID-19 pandemic and a spike in inflation caused wild swings in interest rates, the Fed’s policy rate was between 1.5% and 1.75%. Most experts don’t see the Fed rate going that low again anytime soon, but it could possibly stabilize around 3%.

“It’s certainly a good start,” said Moussa Diop, a USC real estate finance and market expert, referring to the Fed’s announcement Wednesday.

Given that mortgage rates have already priced in some Fed rate cuts — with little effect on the housing market so far — Diop said 30-year fixed mortgages may need to fall below the “psychological threshold” of 6% before they spur more activity among sellers and buyers.

Diop said he fears lower mortgage rates will boost demand for home purchases and in turn push up already high home prices in the short term, offsetting any benefits people might get from lower interest rates.

GU Krueger, an independent housing economist in Los Angeles, said the magic number could be closer to 5%: “That would free up landlords who are eager to move and put out more listings,” he said.

About 60% of homeowners currently have mortgages with rates below 4%, Diop said.

The Fed news Wednesday could “give us a little bit of a boost,” said Michele Birke, a longtime Beverly Hills real estate agent. But “we desperately need a price correction in the market,” she said, adding that the uncertainties surrounding the November election and new rules on broker commissions also provide food for thought.

Businesses say the Fed should have cut interest rates. Small businesses are increasingly reliant on bank financing and have faced a dual challenge in the past two years: high inflation and high borrowing costs.

The Fed began raising interest rates in March 2022, starting with a quarter-point increase. It has raised rates another 10 times through July 2023, mostly in half-point or three-quarter-point increments, in an effort to combat a surge in inflation. Consumer price inflation peaked at 9.1% in June 2022 but has since fallen back to 2.5%, and most analysts see it gradually moving closer to the Fed’s 2% target.

The Fed was slow to raise rates when inflation surged in the second half of 2021, thinking it was more of an accident. And some worry that policymakers are once again late, this time cutting rates even as the labor market has cooled. Job growth from June to August slowed to an average of 116,000 a month, compared with more than 200,000 in the previous three months and over the past year.

Consumer spending, the engine of the U.S. economy, has held up well, but more people, especially in low-income households, are now borrowing to finance their expenses. Average interest rates on credit cards have exceeded 21% this year, according to Fed data.

The Fed’s rate cuts will help, but prices for goods and services could remain uncomfortably high for many households.

“The feeling people get in the supermarket is still very much there. It still hurts,” said Beth Ann Bovino, chief economist at U.S. Bank. “That, combined with higher borrowing costs, is making people feel pretty bad. It’s going to take some time for people to get their finances back under control.”

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This article was originally published in the Los Angeles Times.