Why The Fed’s Lower Rates Will Boost Small Business Earnings

The Federal Reserve’s intention to slash interest rates at its Federal Open Market Committee (FOMC) meeting on Sept. 18, was perhaps the worst kept secret in America. However, the extent of the cut was a source of speculation until Chair Jerome Powell announced a half-percent (50 bps) drop in the Federal Funds rate Wednesday afternoon.

The long-anticipated cut, larger than the typical quarter-percent (25 bps) drop, was the first since the Fed started raising rates in 2022 to curb skyrocketing inflation.

The move came after a split vote at the Fed’s scheduled two-day FOMC meeting on Sept. 17-18 and brings the central bank’s benchmark interest rate down to a new range of 4.75%-5.0%. For more than a year since July 2023, rates have been stuck at the upper range of 5.5%. The figure was the highest seen in more than two decades.

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low,” Chair Powell reported. “Inflation has made further progress toward the (FOMC) Committee's 2% objective but remains somewhat elevated.”

Inflation has slowed throughout 2024. GDP rose at an annual rate of 2.2% in the first half of the year, and data points to a similar rate of growth this quarter. Chair Powell explained that the economic outlook is uncertain, and the FOMC is attentive to the risks to both sides of its dual mandate of maximizing employment and keeping inflation low.

“In light of the progress on inflation and the balance of risks, the committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5%,” he said at his press conference in Washington. “In considering additional adjustments to the target range for the federal funds rate, the committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”

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This could mean additional rate cuts in 2024 and perhaps even into 2025. In assessing its next interest rate move, the Fed will take into account a wide range of information, including labor market conditions, inflation pressures and expectations, and financial market and international developments.

What it means for small businesses

The interest rate cuts could lead to increased lending appetite among traditional lenders, as lower interest rates help rebalance their portfolios. This could result in more borrowers qualifying for bank loans, which typically come with more favorable rates than non-bank lenders offer.

Lower interest rates will lead to reduced interest payments for small business owners. Most small business loans are variable rate loans, and the steady stream of rate hikes initiated by the Fed increased the cost of loan repayments, thereby hurting their earnings. Reduced interest payments for businesses should positively impact their earnings in the short term. Mortgages, in contrast, are often fixed rate, which shields homeowners from enduring the cost of rising interest rates.

Additionally, lower interest rates will lead to reduced interest payments for consumers, which should help improve the country’s overall economic health. Consumers are hurting badly with all the credit card delinquency and with auto loan delinquency at record levels.

During his press conference, Chair Powell said the U.S. economy is in good shape; it is growing at a solid pace, inflation is coming down, and the labor market is strong. This is good news for small business owners whose earnings have been hurt by inflationary costs, as well as high interest rates over the past two years.

One note of caution, however: while short-term earnings may benefit from lower interest rates, the long-term effects on the economy and potential structural changes remain uncertain.

The Fed's decision to cut rates is seen as a bet, and the next few months will reveal whether it leads to a soft landing or a more significant economic impact. Inflation is driven by numerous factors, and the outcome will depend on whether money supply increases lead to higher core inflation or if core inflation remains unchanged. In the coming months, the Fed will no doubt assess the effectiveness of the rate cuts and their impact on the economy to make adjustments accordingly.