As everyone who reads economic newsletters should know by now, the Federal Reserve cut the target overnight lending rate by 0.25% last week. This move should not have come as a surprise to anyone. It was the path of least resistance.
If it didn’t make a cut, the Fed would have seemed oblivious to economic reality. Had it cut more than 25 basis points, it might have appeared the Fed was admitting it was ‘late to the party.’ Either way, the Fed had its proverbial ‘hands tied’ leading into the meeting, and everyone knew it.
But, what does this one relatively small reduction in the amount banks charge one another to borrow money overnight really mean?
Well, the average person with a balance on some kind of revolving debt will see their debt service go down. For instance, if ‘you’ have a $100K on a HELOC ‘floating off of Prime,’ your monthly interest payment on that amount will decrease $20.83.
While not a king’s ransom, it is better than a sharp stick in the eye. Most things are.
Clearly, that amount of money isn’t going to make or break the average American. It simply won’t make a significant impact on their daily lives. After all, what is that, something like $0.68/day? Maybe I/we/they/you could get one of those small boxes of Mike & Ike’s or Hot Tamales? Perhaps two of them?
I honestly don’t know, as it has been a while since I have indulged.
So, why the big furor? Why have the markets been waiting on ‘pins & needles’ for the Fed to start cutting the overnight rate again? I mean, if 0.25% is such a trifling sum, why have we spent all of 2025 speculating, bloviating and pontificating about the Federal Reserve? Wringing our hands and gnashing our teeth about a potential rate cut?
You probably already know my answer. What may seem trivial at an individual level may be massive to an institution, let alone the entire system.
For instance, assume Company X is ‘into its line’ at the bank to the tune of, I don’t know, $20 million. A 0.25% reduction in its interest rate represents a $50,000 decrease in its annual interest expense. Obviously, that starts to get real in a hurry. It is effectively ‘straight profit,’ and it is wonderful.
Now, extrapolate this little example out across the entire US economy, for every borrower of every type. How much newfound profit or spending cash does this mean? Trust me, it is in the hundreds of millions, if not billions, of dollars.
Obviously, investors like that sort of thing. But what about John Doe or Joe Blow? How does this rate cut, or even the next one, really impact him/them? Outside of the potential for a daily, small box of Hot Tamales?
The somewhat inconvenient answer is it probably won’t have much of an impact on those people hurting the most in this economy.
You see, the Fed does directly set longer-term interest rates, arguably the truer cost of capital in the US economy. It only sets the target overnight lending rate and the discount rate. While these might impact other rates, like notably Prime, market forces tend to determine longer ones.
So, Fed ‘rate cuts’ might not have much of an impact on mortgage rates. In fact, Fed rate cuts might actually elevate inflation expectations, which could cause both long-term and mortgage rates to go up.
Further, businesses tend to make hiring plans based on the need for additional capacity. A reduction in interest expense does NOT necessarily increase the need for additional headcount. However, an increase in business activity would. As such, Fed rate cuts only impact hiring to the extent they stimulate economic growth.
Think of it this way. Assume our fictional Company X sells widgets for $15/piece and its Cost of Goods Sold (COGS or the cost of the inputs necessary to make the widgets) is $7.50. How many more widgets will it make IF its COGS were to decrease to $7.25?
Intuitively, Company X wouldn’t make any additional widgets due to a decrease in its COGS unless there was a commensurate increase in demand. At least it shouldn’t. After all, producing more would only increase the supply of widgets on the market, which would ultimately drive down the price X would be able to command.
So, who benefits the most from the first several rate cuts? That is, until they start to have a more meaningful impact on corporate and household income statements and balance sheets? You guessed it, stock investors stand to gain the most in the short term. Of course, they don’t always, but the potential is certainly there.
But what of the renter who doesn’t have, say, a 401k? How does last week’s rate cut impact them? Directly, and truthfully, not that much.
It is sort of like a lyric from a tune by legendary country group Alabama, “Song of the South.” If you know it, you will certainly remember the following:
Well, somebody told us Wall Street fell
But we were so poor that we couldn’t tell
Cotton was short and the weeds were tall
But Mr. Roosevelt’s a-going to save us all
Yep, that about sums it up for a lot of Americans. They have to figure out a way to get food on the table and the check to the landlord. The Fed? Unless Jay Powell shows up on their doorstep with some cash or a check, the Fed might as well be the Wizard of Oz.
So, now what? With one move down, the Fed probably has 3 or 4 more 25 basis points cuts to go. By the time that dust settles and that smoke clears, corporate America should be seeing an increased level of profitability AND American households could be breathing a little easier. However, and obviously, there are no guarantees in life.
Regardless, once we get back to some true sense of normalcy, as it pertains to monetary policy, perhaps we need to have a serious discussion about the Federal Reserve’s power and recent methodologies.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.