Fed slashes interest rates by a half point, an aggressive start to its first easing campaign in four years

The Federal Reserve just made headlines with its first interest rate cut in four years, marking a significant shift in monetary policy. After raising rates aggressively since 2022 to combat inflation, the Fed cut rates by 50 basis points this week—a larger cut than many expected. This signals the Fed's growing confidence that inflation is moving toward their 2% target while they focus on supporting the job market.

The Fed's Big Move

Think of the Federal Reserve as the captain of our economic ship. Their main job is keeping two things in balance: employment levels and inflation. When inflation was running hot—hitting over 9% earlier this year—the Fed raised interest rates aggressively to cool things down. It's like tapping the brakes when you're going too fast down a hill.

This week, the Fed gained enough confidence that inflation is moving sustainably toward their 2% target to make their first rate cut since March 2020. They lowered the federal funds rate by half a percentage point to a range between 4.75%-5%. Outside of the emergency rate reductions during Covid, the last time they cut by half a point was in 2008 during the financial crisis.

Fed Chairman Jerome Powell emphasized that inflation is "much closer" to the 2% target and the labor market is "less tight" than it was before the pandemic. The Fed's projections suggest they're planning the equivalent of 50 more basis points of cuts by the end of this year, with another full percentage point in cuts by the end of 2025.

Why the Fed Does This at All

The Federal Reserve uses interest rates like a thermostat for the economy. When they raise rates, borrowing becomes more expensive, which tends to slow down spending and investment—cooling off an overheated economy. When they cut rates, it's cheaper to borrow money, encouraging people and businesses to spend and invest more, which stimulates growth.

The Fed doesn't arbitrarily pick these numbers. They're constantly analyzing employment data, inflation reports, and economic growth indicators. Their goal is what economists call a "soft landing"—bringing inflation down without triggering a recession. Recent data shows the economy is still growing at a solid pace, but job gains have slowed and unemployment has ticked up slightly, though it remains low.

Bond Investors

If you hold bonds in your portfolio, Fed rate changes create a seesaw effect. When the Fed cuts rates, existing bonds with higher interest rates become more valuable—like owning a classic car that's no longer made. Here's why: if you own a bond paying 5% interest and new bonds are now only paying 4%, your bond becomes more attractive to other investors, increasing its market value.

This price appreciation can provide capital gains in addition to the interest income you're already receiving. Over the last 12 cutting cycles, fixed income has outperformed cash in all but one. Bond yields are likely to fall lower from here, which creates an opportunity to consider moving out of excess cash positions that may be earning less over time.

On the flip side, when you reinvest maturing bonds or buy new bonds, they'll likely offer lower interest rates than what you might have locked in earlier. This is simply the natural cycle of bond investing—you benefit from price appreciation on existing holdings while accepting lower yields on new purchases. We focus on building diversified bond portfolios that can navigate these changes while providing steady income over the long term.

Your Mortgage and Loans

Here's where things get a bit counterintuitive. While you might expect Fed rate cuts to immediately lower mortgage rates, the relationship isn't quite that simple. Mortgage rates are primarily tied to the 10-year Treasury yield, not the federal funds rate directly.

Interestingly, mortgage rates have already been falling in anticipation of this cut. The average 30-year mortgage rate dropped to 5.89% just before the Fed's announcement—its lowest level in over two years. However, rates can be unpredictable; they actually went up the day after the Fed's cut due to other economic factors.

For adjustable-rate mortgages and home equity lines of credit, the connection is more direct. These typically adjust within two billing cycles after a Fed rate change, so you should see some relief in your monthly payments if you have these types of loans.

Your Investment Portfolio

Historically, when the Fed cuts rates outside of recession, equities tend to deliver strong performance. Lower interest rates make stocks more attractive compared to bonds and savings accounts, and they reduce borrowing costs for companies, potentially boosting their profits.

The rate cut is likely to support growth and stabilize the slowing labor market, which could extend the current economic cycle. However, markets are forward-looking, so much of the good news from this rate cut may already be reflected in current stock prices.

The Bigger Picture

What's most important to understand is that the Fed's actions reflect their confidence in the economy's direction. The fact that they're cutting rates while the economy continues to expand suggests they believe they can achieve that elusive soft landing.

For your financial planning, this environment calls for patience and perspective. Interest rates are normalizing from the emergency levels we saw during the pandemic, but they're unlikely to return to the ultra-low rates of the 2010s. The "new normal" will probably be somewhere in between.

The key is building a financial plan that can weather different interest rate environments. Whether rates continue to fall or stabilize from here, having the right mix of investments, maintaining good credit, and staying focused on your long-term goals will serve you well.

As always, these broad economic trends affect everyone differently based on their unique circumstances. If you have questions about how these changes might impact your specific situation, let's schedule a time to talk through your portfolio and financial plan.

As always, this general information doesn't constitute personalized financial advice. Feel free to reach out if you'd like to discuss how any of these developments might affect your specific financial plan.