This Friday (August 22) Federal Reserve Chairman Jerome Powell will give a speech at the Jackson Hole Symposium. There is intense speculation concerning what Chair Powell will say and whether or not he will signal upcoming rate cuts. The path forward is anything but certain and the increased pressure from the administration to lower rates (this week it was a call for a voting Fed Governor to resign) certainly muddies the waters.

All that aside, a client recently asked what impact a rate cut will have on every day life if and when it occurs. That’s a great question and one that may warrant your attention – so let’s dive in.

As a quick recap – the Federal Reserve Bank is in control of monetary policy of the United States. One of the Fed’s primary tools to influence its dual mandate (steady prices and stable employment) is to adjust the federal funds rate. This is the interest rate banks charge each other for overnight loans. It is considered the base lending rate and while individuals don’t pay the fed funds rate, it does impact many other interest rates that impact consumers and investors.

The Fed Funds rate is currently between 4.25 – 4.5%. The Fed last cut rates in December 2024. That level is in line with historic averages but far higher than the near-zero rates America saw for much for the post-2008 financial crisis period. As inflation starts to cool (even in the face of tariffs) and labor market starts to wobble a bit, there is a growing expectation (and political pressure) that the Fed may start to lower rates. Why? Lowering rates can spur added borrowing and further economic activity (see more detail on reasons to seek rate cuts here)

Now on to the main question – if the fed funds rate is cut, what are the carry-thru impacts to end consumers and investors?

Lower borrowing costs – while borrowers don’t pay the fed funds rate per se, that rate does influence other key rates in the system including the prime interest rate. Prime is used to set interest rates on many common borrowing instruments including home equity loans, lines of credit, and credit card debt. A fed rate cut should quickly lead to some relief of these common consumer variable rate.

It’s important to note that other key types of borrowing (like mortgages, business loans, and car loans) are not directly tied to fed funds. These longer-term rates are influenced partially by the fed funds rate but also other market driven factors like long-run inflation and growth expectations. So there may not be as direct of a correlation in these rates.

Lower earnings on cash – one hidden benefit of rising rates in the post-COVID era has been the ability to earn a very meaningful yield on cash and cash equivalents including bank accounts, CDs, and money market funds. Investors have certainly become accustomed to this dynamic and see 3-4% as the “new normal” yield on cash. As rates are cut, these rates on cash instruments will decline in lock step

Lower yields, higher prices – the impact of rates on fixed income securities (ie: bonds) is always a bit complicated to understand but just remember – it’s an inverse relationship. If rates fall (again, impacted by fed funds rate and other economic dynamics), the value of fixed income instruments will rise. Why? The existing bond that pays a higher rate of interest is now worth more than a new bond that will pay at the lower prevailing rate. However, the income stream from fixed income will also decline over time as new bond issuances will pay at the new (lower) market rates

Tailwind for equities – Typically, lower interest rates is a benefit to equities for a few main reasons. First, if equity prices are the present value of future cash flows, a lower denominator in that equation (cash flows divided by interest rate) will raise the result. Second, lower rates allow businesses to access capital at lower rates. This lowers their expenses, increases their profitability, and allows them to use that capital to drive further growth and innovation. Lastly, investors are ultimately allocating capital to the highest and best use. When rates are high, fixed income is a competitive alternative. However, when rates decline, equities often start to look better in comparison and may garner added fund flows in order for investors to reach their long-term return objectives.

As you can see, there are real-world impacts of the Fed Funds rates and that quite frankly is the whole point. The Federal Reserve controls the top line rate and then relies on the follow-thru effects to drive its intended outcome. Change to the fed funds rate will come – eventually. The time to start preparing for it is now, so be sure to reach out to your advisor and talk thru the implications for your specific situation.