On Wednesday, the Federal Reserve decided to hold rates steady again—but all eyes are already looking towards the Fed's September meeting, when many economists and investors believe the first rate cut will be announced.
The Federal Open Market Committee (FOMC) went into their July meeting with the recently revised outlook that they may cut rates as many as two times in 2024—down from the three cuts they anticipated earlier in the year, but up from the one cut they discussed more recently.
However, even when they do cut rates, the impact to the overall economy will take time, said BOK Financial® Chief Investment Officer Brian Henderson. "From an economic standpoint, if they cut twice this year, it won't be a huge impact, and the rule of thumb is that it will take nine to 18 months before the economy feels the full brunt of rates going higher or, in this case, rates coming down," he explained.
At the same time, individuals and businesses may almost immediately feel the impact of even just one cut on their debt costs, as well as the interest paid on some savings and investment vehicles, he continued.
"If you're a money market fund investor, it's less yield right away. Meanwhile, if you're a borrower, whether an individual or a business, and you're having to pay less interest on your debts, it may be pretty significant."- Brian Henderson, chief investment officer at BOK Financial
The interest paid on some other savings vehicles, such as certificates of deposit (CDs) and traditional savings accounts, will also decrease as the Fed drops the Federal Funds rate.
However, for those looking to buy a home, the connection isn't so direct. Mortgage rates are influenced by the Federal Funds rate but not directly correlated. Although they tend to move up and down together, some have speculated that mortgage rates won't fall when the Fed cuts rates.
Has the Fed waited too long to cut rates—or just enough?
Since monetary policy operates with this nine-to-18-month lag, some have posited that the Fed already may have waited too long to make the first rate cut. Most prominently, on July 24, former New York Federal Reserve President William Dudley strongly advocated for the Fed to cut rates at its July meeting, which the FOMC did not do. Dudley's opinion was a surprising turn since he previously had been a strong proponent of the Fed's "higher-for-longer" approach. "Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk," he explained.
One reason for Dudley's about face is the labor market—in particular, the three-month average unemployment rate, which he notes is close to the 0.5 threshold that has signaled a recession under the Sahm rule.
However, year-over-year unemployment was still only 4.1% as of June, a figure that Henderson said is not concerning. "If you were to look at a 4.1% unemployment rate over long periods of time—40 years, 50 years—you would see that 4.1% is very much on the low end of the range," he explained.
Looking forward, he expects the U.S. economy to continue on this positive path.
"Consumer spending has slowed down a little bit, but it's still pretty good, and I'm still optimistic that that job growth is going to continue. We still have a vacancy-to-unemployed rate of 1.2. That has come down from a couple of years ago, but it's still high. And so, the demand for qualified employees to fill open positions is still above average."- Brian Henderson, chief investment officer at BOK Financial
Some analysts are anticipating that the Fed even may achieve the rare event of an economic "soft landing"—that is, inflation dropping to the Fed's target of 2% without a recession. These hopes for a soft landing were reignited by the release of second-quarter gross domestic product (GDP) numbers, which showed the economy had grown by 2.8%, faster than many expected.
Inflation slowing but still high
Meanwhile, the personal consumption expenditures (PCE) price index showed that year-over-year inflation had slowed to 2.6% during the quarter, down from 3.4% in the first quarter. Core PCE was at 2.9%, compared to 3.7% in the first quarter, the report showed. And so, while inflation is still over the Fed's target, it was moving in the right direction during the quarter.
However, the question of when inflation will fall to 2%—and if that's even possible with shelter costs so high—still stands. Henderson believes that 2% inflation might be a year away and, even when it does decline to that level, the Fed may still have to keep rates on the high side—though lower than where they are now.
"Shelter costs and other services are still lingering very high, and I think that's going to remain an issue for years to come," Henderson said. "When we had extremely low inflation rates in the past, it might have been an anomaly. We're in a different environment now.
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