The Federal Reserve is widely expected to start cutting interest rates this week, marking an inflection point in the economy.
The move is expected to have an effect on financing rates in various consumer sectors, as well as on labor and employment conditions.
It isn’t known how quickly subsequent rate cuts will happen or what the terminal interest rate will be, though Fed Chair Jerome Powell told lawmakers earlier this year that the era of near-zero interest rates is probably over. Fed projections show the median interest rate dropping to 4.1 percent next year and 3.1 percent in 2026.
Banks are preparing for the possibilities of both a quarter-point rate cut and a half-point cut.
“If the Fed opts for a [quarter-point] reduction, the Chair will have to project confidence about the outlook and assuage concerns about the Fed falling behind the curve,” Deutsche Bank analyst Matthew Luzzetti and others wrote in a commentary Tuesday.
“Conversely, if they cut by [a half-point], Powell will need to avoid sending negative signals about the economy and dissuade markets from pricing a sequence of large reductions,” they added.
Here are five ways workers and consumers are likely to perceive interest rate cuts in the economy.
Mortgage rates will come down
The housing market is still enduring a shortage of units, and the longer-term trend of asset inflation is compounding affordability issues in the sector. That has increased rent burdens.
But a drop in interest rates should allow mortgage rates, which have already been descending, to fall further. The 30-year fixed rate mortgage is currently at an average of 6.2 percent, its lowest level since February 2023.
Mortgage rates move in sync with the 10-year U.S. Treasury yield, but are undergirded by the Fed’s interbank lending rates.
“Banks borrow money to lend it out. They borrow from each other, they borrow from the Fed. When interest rates … go down, then they can lend out to companies and to people at lower rates,” economist and former commissioner of the U.S. Bureau of Labor Statistics Erica Groshen told The Hill.
Auto loan rates should also decrease
Interbank lending rates also undergird the price of new auto loans, along with other types of financing, and these are expected to come down as interest rates fall.
The average new car loan rate is 9.61 percent while the used car rate is 13.91 percent, according to Cox Automotive.
Auto industry analysts have been noting positive trends in consumer sentiment, along with falling prices of gasoline.
“Despite a weaker labor market, consumer sentiment continues trending higher,” Cox Automotive economist Jonathan Smoke said in a Tuesday presentation. “The average unleaded gas price, according to AAA, declined 1.9 percent week-over-week to $3.21 per gallon as of Sunday, which was down 17 percent year-over-year and is providing relief to consumers.”
It will be less lucrative to save money
While interbank interest rates support consumer financing rates, they also buttress savings rates, so returns on savings accounts, money market accounts and certificates of deposit are likely to go down, as well.
When consumers lend money to banks in the form of taking out a savings account, they typically get a much lower return on their money than the banks themselves get for lending money to each other. The national deposit rate for savings was just 0.46 percent in August compared to the 5.33-percent interbank lending rate.
But that’s still relatively high compared to the 0.06-percent savings rate clocked just before the Fed started raising rates in 2022.
Other savings products have higher yields, but will likely see a drop, as well. The average annual percentage yields for certificates of deposit are 1.78 percent for a 1-year, 1.41 percent for a 3-year, and 1.42 percent for a 5-year, according to Bankrate.
Some money market accounts have had rates above 5 percent in recent years, leading some big investors to pull their money out of securities and enjoy a guaranteed return that beats many index funds.
This has led to a hypothesis that higher interest rates may have actually been contributing to higher inflation through interest income pumped back into the economy, a phenomenon that, if accurate, is likely sequestered to very wealthy households. The government doesn’t track consumption resulting from interest income in this way, so it’s hard to be sure.
Employment conditions could improve down the line
During the booming recovery from the pandemic, there were two open jobs for every job seeker, which resulted in a lot of job switching as well as an acceleration in wage earnings for some of the economy’s least paid people. Those favorable conditions for workers were occurring while the unemployment rate was at the lowest level since the late 1960s.
Following interest rate hikes by the Fed, as well as an influx of immigration, employment conditions have tightened significantly, and there are now fewer private sector positions available than there are people out of work. The unemployment rate is still low in absolute terms at 4.2 percent, but worker-friendly conditions have diminished significantly.
However, as the Fed cuts rates and spurs investment in the economy, more jobs could become available and labor conditions could favor workers in a more pronounced way.
The relation between rate cuts, employment levels, investments, and returns on investment has been refined over the years, but is basically the same as it was in the early part of the 20th century.
“The scale of investment is promoted by a low rate of interest, provided that we do not attempt to stimulate it in this way beyond the point which corresponds to full employment. Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment,” economist John Maynard Keynes wrote in a seminal 1935 economic textbook.
Low interest rates could support a new fiscal environment
Following the passage of several landmark pieces of legislation in the first half of the Biden administration — including a major infrastructure law, a semiconductor fabrication package, and a climate technology law — investments in the U.S. economy, particularly in manufacturing construction, have taken off.
While hiring in the U.S. manufacturing sector has yet to match the scale of investment, a low interest rate environment could complement these changes in the economy, supporting further domestic investment.
Economists told The Hill that these changes, sometimes referred to as a return to U.S. industrial policy, really come down to productivity gains that policymakers would like to see in the economy and that they could ultimately have an effect on U.S. deficit levels.
“The big unknown here is how much this new approach to fiscal policy achieves its intended goal of increasing productivity. If we get the productivity benefits that were the aim of these changes, then that becomes the root to bring the deficit down,” Erica Groshen told The Hill.