How the Federal Reserve’s September Rate Cut Impacts Investors and the Economy

The Federal Reserve (Fed) recently cut interest rates by 0.50%, a move that carries broad implications for both the economy and financial markets. After more than a year of holding rates steady, and months of debate over how large the first cut would be, the Fed’s decision reflects a shift in focus as inflation cools and labor market dynamics come to the forefront.

With inflation now sitting around 2.5%—a significant drop from its peak of 9.1% in 2022—the Fed’s efforts to curb rising prices appear to be paying off. But this victory is tempered by growing concerns over the labor market. Payroll growth has softened, and job creation is weakening, prompting the Fed to act to prevent a further economic slowdown. The Fed’s dual mandate is to promote maximum employment while ensuring price stability. This rate cut highlights the central bank’s increasing focus on the labor market and recognition that inflation is largely under control.

Lower interest rates have widespread effects across the economy. For consumers and businesses, it means cheaper borrowing costs, whether for mortgages, corporate loans or credit card debt. Small- and mid-sized companies are particularly well-positioned to benefit from lower rates, as they are more reliant on credit to fund growth and manage operations compared to larger corporations.

For investors, the rate cut presents multiple opportunities. Lower interest rates typically boost stock valuations by reducing the discount rate on future earnings, conversely increasing valuations. This can especially benefit small-cap stocks, which have lagged behind their larger counterparts in recent years. The Russell 2000 Index, a key benchmark for small-cap stocks, has been relatively flat over the past three years, while large-cap stocks surged. The dominance of a small group of large technology companies, known as “The Magnificent Seven,” has been a defining feature of recent market gains. These companies have commanded a large and growing share of the S&P 500, representing about 34% of the index at one point this year. However, lower interest rates could pave the way for smaller companies to experience a resurgence, and a more diversified market rally could follow, which would be healthier for investors in the long run. We have seen a broadening of the stock market rally since July.

Bonds also tend to benefit in a falling rate environment, as lower rates increase bond prices and provide potential capital appreciation for investors. This creates a more favorable environment for both equity and fixed-income investors, particularly those who have been challenged by higher rates.

Looking ahead, the big questions are whether the Fed will continue cutting rates, for how long, and how fast? Current market expectations suggest that the Fed Funds rate could drop to 4.4% by the end of 2024 and 3.4% by the end of 2025— this depends on how labor market conditions evolve and whether inflation remains stable.

Investors should remain focused on long-term strategies and diversification. If you have questions or would like to discuss how the Fed’s recent rate changes may influence your investment strategy, we are here to help.