Fed Rate Cuts Will Boost Wallets, but a Shift in Mood May Take Time

By Howard Schneider and Ann Saphir

WASHINGTON (Reuters) – Financial markets had already begun to lower credit costs for households and businesses before the Federal Reserve enacted a substantial half-percentage-point interest rate cut last week. This has led to decreasing mortgage rates, lowered corporate bond yields, and reduced costs for personal, auto, and other loans.

The pace at which this trend will continue, particularly how quickly credit conditions will improve for consumers ahead of the U.S. presidential election on November 5, remains uncertain.

Surveys indicate that although the rate of price increases has slowed significantly, the public’s sentiment has been negatively affected by nearly two years of high inflation. Even as falling rates suggest an end to that chapter of economic history, it remains to be seen if consumers will feel the impact in their borrowing costs.

"My daughter has been trying to buy a home for years and cannot," shared Julie Miller, an employee at her son’s electrical company in Reno, Nevada, where home prices surged during the COVID-19 pandemic. Nevada, a critical battleground state in the presidential race, is fiercely contested by Vice President Kamala Harris, the Democratic nominee, and former President Donald Trump, the Republican candidate.

While Miller’s daughter struggles with housing costs, rising prices at Taco Bell have led Miller to cut back on her customary Friday night outings with her granddaughter. This has left her more inclined to support Trump, as she feels "Biden hasn’t effectively handled inflation."

Supporters of Harris echoed concerns about high prices, even as they touted her as the best candidate to tackle these issues.

DECLINE IN BORROWING COSTS

The Fed’s rate cut on September 18 is expected to be followed by further reductions, including at least another quarter-point cut during the next two-day policy meeting just after the U.S. election.

Just as interest rate increases lead to higher borrowing costs and discourage spending and investment to curb inflation, lower borrowing costs shift the balance for potential homebuyers and small businesses looking to finance new equipment or expand their operations.

A more accommodative monetary policy, which the Fed has indicated is forthcoming, has already begun putting money back into people’s pockets. For instance, the average interest rate on a 30-year fixed-rate mortgage is nearing 6%, down from nearly 8% a year ago. A recent estimate revealed that median payments on homes sold or listed in the four weeks leading up to September 15 were $300 less than the all-time high in April and nearly 3% lower than a year earlier.

However, with these adjustments already underway, "mortgage rates are likely to stabilize in the coming weeks," noted economist Chen Zhao. The Fed’s projections suggest that mortgage rates may settle in the mid-5% range, indicating that the bulk of relief has already occurred.

Banks have started lowering the "prime rate" they offer to their most creditworthy customers in response to the Fed’s rate cut. Other consumer credit products, such as auto and personal loans, have seen only minimal changes, and it may take more time for banks to shift away from charging higher rates.

Investors and economists regard last week’s rate cut as significant not solely for the reduction itself but for the message it sends about the Fed’s readiness to loosen credit and its confidence that recent high inflation trends will not return.

Indeed, inflation has dropped rapidly, with the consumer price index’s annual increase falling from over 9% in June 2022 to 2.6% last month. The Fed’s preferred index for personal consumption expenditures rose at a 2.5% rate in July, close to the central bank’s 2% target.

MIXED SENTIMENT

Despite these economic indicators, public sentiment has not shown a decisive improvement.

The share of Americans who believe the economy is heading in the right direction rose to 25% in August, up from 17% in May 2022. However, those who feel the economy is on the wrong track still account for 60%, down from 74% in the same period.

A survey by the New York Fed, which previously showed people feeling more optimistic and anticipating improvement, has since reflected a shift in sentiment even as inflation continues to slow and rate cuts become more likely.

Although the University of Michigan’s consumer sentiment index had been rising, it has dropped in recent months and remains lower than pre-pandemic levels.

Recent U.S. Census "pulse" polls indicate that while the percentage of households reporting difficulties in paying their expenses has decreased since the height of inflation in 2022, there has not been significant recent improvement.

In his press conference following the recent rate cut, Fed Chair Jerome Powell stated that his goal is to keep the economy balanced between stable inflation and a healthy job market. He noted that credit conditions will ease, though the pace remains uncertain.

"This is the beginning of that process," Powell remarked. "The direction is toward a sense of neutral, and we will adjust as needed."