The Federal Reserve has a HUGE decision this week - here’s what it means for you

Read time: 5 1/2 minutes

By September 18th at 2pm the Federal Reserve will make a decision investors have been waiting on for over a year - they’re going to cut interest rates.

I’ll take a moment for you to run around the room losing your mind.

……

You done?

Ok. Good. Because here’s where it gets really spicy.

They’re going to decide whether to cut rates by 0.25% or 0.5%.

Oh mY GoSH ThIS iS crAZyyyy!!!

Hey.

Hey!

HEY!!

Calm down.

I know this news has shaken you to your core, but sit down for a second and I’ll explain what it means and how it affects you.

Come on, come back over here.

That’s right.

Deep breaths.

Take a seat. 

Sheesh.

You’re so dramatic.

In today’s issue:

• What does the Federal Reserve even do?

• Why do interest rates matter?

• How will Wednesday’s news affect you?

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What does the Federal Reserve even do?

In the simplest terms possible, the Federal Reserve is in charge of the United States’ money supply and its banking system.

And they exist to achieve two main goals - keep our financial system stable (no bank runs, low inflation, etc), and keep employment as high as possible.

To achieve those goals they do 5 main things:

1. Act as a bank for banks (checking accounts, savings accounts, loans - pretty much everything your bank does for you, the Fed does for your bank)

2. Act as a bank for the government (same idea, in addition to printing money to pay for the budgets Congress passes)

3. Supervise banks to make sure they’re not being shady

4. Manage US monetary policy

5. Manage inflation

Raising or lowering interest rates (what they’re deciding on this week) is their #1 tool for impacting both US monetary policy and inflation levels.

And what they choose will have massive consequences for the US economy - possibly pushing it into a recession or bringing back high inflation if things go wrong.

Here’s why…

Why do interest rates matter?

The Federal Reserve sets something called the federal funds interest rate.

This interest rate is used as the benchmark for almost all other interest rates in our economy.

• Mortgage rates

• Credit card interest rates

• Car loan interest rates

• Savings account interest rates

• Business loan interest rates

• You get the idea…

If the Fed raises this interest rate, all of those other interest rates also go up.

If they lower it, those other rates drop too.

And this has a HUGE effect on our economy.

Or as Trump would say, YUGE.

When interest rates are low, it’s really cheap to borrow money so a lot of people do it.

That means more people and companies have money to buy things, which makes the economy grow faster.

Companies then have to hire more people to keep up with the demand for their stuff. Unemployment goes down. This is good.

Unfortunately, it also causes inflation to rise.

If more people want to buy something, more people will fight each other to buy it (picture Black Friday shopping).

That causes the price to go up.

Prices going up = inflation.

So when the Federal Reserve wants to drop inflation (like over the last few years) they’ll raise the federal funds interest rate.

That makes it more expensive to borrow money, which means fewer people can afford to buy things.

Fewer buyers = less competition to buy the same stuff = lower prices.

Think about how hard it is to buy a house right now. Not only are prices higher, the mortgage rates are higher, making the payments unaffordable for lots and lots of would-be buyers.

This pushes people out of the house-buying market, which pushes prices down (or at least keeps them from rising as quickly).

The problem with this is, higher interest rates slow down the economy which can lead to layoffs and high unemployment.

So the Federal Reserve has to walk this delicate tightrope of keeping interest rates just high enough to keep inflation down, but not too high so they don’t squash the economy and cause a recession.

Over the last few years inflation has been too high.

In response, the Fed raised interest rates from 0% all the way to 5.5%.

It took a few years, but it worked. The latest inflation reports have inflation close to the 2% inflation rate the Federal Reserve tries to hit.

Job well done. Pat yourself on the back. Go home and celebrate.

Exceeeeept….

If they keep things as they are, they risk choking the economy too much. That inflation drop can turn into a recession real fast.

So just like a pilot landing a plane, they’re about to bring interest rates back down to try to ease the economy into a nice, soft landing and avoid the recession we talked about last week.

You tracking with me?

A small cut might not be enough to fend off weak job growth and avoid a recession, but a large cut might be too much and cause inflation to rebound and go back up.

This is why investors are so interested in what the Fed decides to do. Their decision impacts the future strength of the economy.

Will this be a small, delicate 0.25% rate cut, or a big, meaty 0.5% cut?

And most importantly for us…

How will Wednesday’s decision affect you?

Here’s what each scenario would likely mean for the market and for you.

A 0.25% rate cut:

• This is the lightest option. The market is least likely to freak out if this happens.

• The stock market probably won’t change too much since most people have been expecting this result for weeks already. It could drop slightly as people first react to it. It could even go up. Hard to tell for certain.

• Mortgage rates would drop slightly, leading to a rush to buy homes, pushing house prices higher.

• Interest rates on savings accounts and bonds will come down slightly.

• Companies might green light more investment projects since borrowing money for them is now cheaper. This could bolster the economy.

A 0.5% rate cut:

• This would be seen as a sign the economy is about to be flush with cash and ready to boom. 

• The stock market would likely jump up very quickly in the first few hours after the news.

• Mortgage rates would come down significantly, causing a fall home price surge as buyers rush to buy homes with now more affordable mortgages.

• Interest rates on savings accounts and bonds would drop significantly. This would probably push more people into buying stocks, pushing stock prices up even more.

• Companies might invest even more money into new projects, causing them to hire more people, pushing unemployment numbers lower.

• The rush of people borrowing and spending money could cause inflation to go back up, leaving working class Americans high and dry as they watch their buying power shrink again.

A surprise 0% rate cut:

• This would be a signal the Fed is still concerned about inflation being too high. At this point, this would be a shocking decision. Almost no one expects this. But it is what they’ve done the last few meetings.

• The stock market would likely temporarily crash.

• Mortgage rates would remain high, pushing down on stubbornly high home prices.

• Interest rates on savings accounts and bonds would stay high. Fewer people would transfer their money to stocks, which would push stock prices down further.

• Investments from companies would likely continue to slow down as the cost to borrow remains high. This would lower the growth of the economy, and could make a recession more likely.

What should you do about it before the news breaks?

That’s up to you. Probably nothing.

If you’re looking to buy a home, a 0.5% rate cut would mean you should buy one sooner than later.

Cheaper mortgage rates are going to flood the housing market with buyers, pushing home prices even higher.

Better to lock in a good price on a home now with a bad mortgage interest rate, then refinance in a year or two if rates keep coming down.

If you have some medium-term savings and you’d like to earn a high interest rate on them, Tuesday might be the best time to lock in a CD for a while. Banka account earnings have already come down and might come down even more.

If you’re an investor looking at your stocks and wondering if you should sell anything, the answer is no.

Trying to predict the result and make an investing move beforehand is like sports betting.

It feels fun but is destined to lose if you do it enough.

Investing is about the long game, not short-term or even year-long drops or rises.

Take the news - whatever it is - and use it to make you better informed about where the economy is headed over the next few years.

Then go take a walk outside. It’s September. It’s beautiful out there.

And as always,

Keep growing,

Still have questions about what the Fed does? Reply to this email with your question and I’ll help you figure it out.

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