If the Federal Reserve Cuts Interest Rates, What Happens Next?

A rate cut would help, but don’t expect too much too soon. 

When the Federal Reserve meets in mid-September, many people are expecting an interest rate cut. In fact, one forecasting tool — the CME Group’s FedWatch — says the real question is whether the Fed cuts the federal funds rate by a quarter-percentage point or half a percentage point. 

Critics have been calling for a rate cut for months, arguing that inflation has slowed enough and higher rates are putting the economy at risk of recession. Now, because of an increase in the unemployment rate, combined with continued progress on inflation, the Fed might be ready to take action. 

“The broad sense of the committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate,” Fed Chair Jerome Powell said after the July meeting of the Fed’s Federal Open Market Committee.

“In that, we will be data-dependent but not data point-dependent, so it will not be a question of responding specifically to one or two data releases. The question will be whether the totality of the data, the evolving outlook, and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labor market.” 

Assuming that a rate cut does move forward, what kind of impact will it have?  

How a rate cut could affect the economy 

For starters, consumers will have a little more breathing room. Car loans, credit cards and other forms of debt would be less expensive. 

It’s hard to estimate how quickly a rate cut will impact the larger economy, though. A small cut might spike the stock market, but it’s unlikely to spur a massive amount of growth immediately.

After all, even with a cut, the federal funds rate would be around 5%, which is still relatively high compared to the last several years. Lower rates could encourage some consumers and businesses to spend more, but others will decide to wait for further cuts to reduce borrowing costs even more. 

One rule of thumb is that a cut will take at least 12 months to show up in the larger economy, but as Sarah House, an economist with Wells Fargo, told Marketplace: 

“It’s hard to say, because a lot of times when the Fed is cutting rates, it’s because the economy is already in a downturn. And so in some ways, it’s hard to really separate how much the rate cuts are doing when you already have a lot of other negative forces.”

A gradual return to stronger growth might be preferable if it prevents inflation from roaring back and driving prices higher. 

Will there be other cuts this year?

A few months ago, the Fed predicted that it would cut interest rates only once this year, but the rise in unemployment could change that calculation. A handful of economists have already started to look for other rate cuts this year. 

In mid-August, for example, FedWatch forecast an 81.3% chance of the federal funds rate dropping to at least 4.25% to 4.50% by the end of the year — a cumulative reduction of 1 percentage point from its current level.

The Fed will certainly have the opportunity to cut rates more than once. In addition to its September meeting, the Federal Open Market Committee (FOMC) is scheduled to meet two other times this year: Oct. 31-Nov. 1 and Dec. 12-13. 

Until the Fed reconvenes, it’s good to remember the unexpected can still happen. 

Heading into 2024, the Fed had predicted that it would make three rate cuts this year. Some economists and investors thought six or seven cuts were possible. Then inflation ticked up in the early months of the year, and for most of 2024, many forecasters said only one rate cut was likely. 

The bottom line on potential interest rate cuts

A rate cut in September would be a first step toward more affordable capital for companies that need to borrow. 

However, the cost of borrowing might still be too high for some companies. In that case, alternatives like dynamic discounting and supplier finance programs could allow them to increase their cash flow without paying higher interest rates. 

If your company needs access to working capital, C2FO offers a range of potential options, including our best-in-class Early Pay solution. Learn more about how the program works here, or check to see if any of your customers offer Early Pay to their suppliers.