Fed Rate Cut Certainty: Mapping Consumer and Business Debt Impacts

The only question surrounding rate cuts from the Federal Reserve boils down to not “when?” but … “how much?”

The central bank seems all but certain to tamp down interest rates, cutting the Fed Funds rate for the first time in almost exactly four years. The Fed Funds rate is the benchmark for all sorts of other interest rates, covering a range of debt instruments, from cards to business loans to mortgages.

Whether we see a 0.25% cut or a 0.5% cut — and whether there will be a string of cuts through the next few months — the overarching trend is that borrowing will be less costly than it had been before.

But it will take time for the ripple effect to be felt through various corners of the economy. As the Federal Reserve Bank of St. Louis noted in a blog posting at the end of last year, it can take as long as two years for monetary policy changes to truly impact inflation, but the shift in some interest rates on some classes of debt and assets can and will change sooner.

Here are some trends to watch:

Savers May Move Money Around

Though high interest rates make debt more expensive (and less attractive to take on), they make savings accounts more attractive to build up, as savers earn more on their money parked with a financial institution (FI), as annual percentage yields remain lofty. But as the Fed moves rates lower, the yields on savings (particularly high yield) accounts and money market accounts will move lower too. It may be the case that consumers will take the funds that have accumulated and will chase yield (or lock funds into a relatively higher yielding CD, where that money is in effect tied up) or pay down debt (see below for card-related musings).

Mortgages May Be Stagnant

Current mortgage rates are touching between 6% to 7% depending on one’s credit score and the size of the mortgage. It would take a significant cumulative impact from Fed cuts to shift mortgage rates lower by enough to spur a boost in home-buying or refinancing. Rates are well south of the most recent peak of more than 8%, and it might be argued that the recent downward trend may have already been in the cards, anticipated by the markets and by lenders.

Businesses May Be More Sanguine About Borrowing

Similarly, the repricing of fixed-rate debt for businesses, through working capital term loans, may have a reset that takes place gradually; business lines of credit, variable in nature, would see lower interest rates over time. But for small and medium-sized businesses (SMBs) looking to tap new credit, as 60% of SMBs are struggling with cash flow, borrowing may be a bit more palatable.

Card Debt — Paying Down or Padding the Balances?

As we spotlighted in our recent coverage of consumer credit, via Federal Reserve stats, the July data on consumer credit shows a significant jump in pretty much all forms of debt. Revolving debt, which includes cards, surged at an annualized 9.4% pace in July. Overall revolving debt stood at $1.359 trillion in the latest reading; that line item had been a “mere” $1 trillion in 2019, so debt levels are roughly 25% higher. Lower interest rates could interest consumers in new cards or spending more on those cards, but it seems that some digesting of the recent debt loads will be in order.

PYMNTS Intelligence data has noted that through the past few months, 15% of Generation Z said repaying debt is a priority, a sentiment echoed by 22% of baby boomers, 23% of Generation X consumers, 20% of bridge millennials and millennials, and nearly 19% of zillennials.

For paycheck-to-paycheck borrowers, we note that cards earning interest charges are seeing rates at north of 22%. Variable debt “reprices” faster than fixed rate debt. But given the recent historically high levels on card debt, it would take a while for real financial impact to be felt. After all, inflation’s still touching 3%, and so the “buying” power of take-home pay, and the ability to use it — after expenses are met — to pay down debt remains limited. PYMNTS has estimated  that more than a quarter of take-home pay covers the essentials of food and lodging, and for the lowest-income consumers that share surges to roughly three-quarters of take-home pay.

The initial euphoria of a September rate cut may be most keenly felt in the stock market — but the real effect felt on the family budget (and wallet) will take more time.

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