Why Lower Fed Interest Rates Will Boost Small Business Profits

WASHINGTON, DC: Federal Reserve Chairman Jerome Powell speaks at a press conference on September 18, 2024. … (+) in Washington, D.C. The Fed cut interest rates by 50 basis points amid falling inflation and a weakening labor market, marking its first rate cut in more than four years. (Photo by Sha Hanting/China News Service/VCG via Getty Images)

China News Service via Getty Images

The Federal Reserve’s intention to cut interest rates at its Federal Open Market Committee (FOMC) meeting on September 18 was probably the worst-kept secret in America. But the scale of the cut was a source of speculation until Chairman Jerome Powell announced a half-percent (50 bps) drop in the federal funds rate on Wednesday afternoon.

The long-awaited cut, bigger than the typical quarter-percent (25 basis points) cut, was the first since the Fed began raising rates in 2022 to curb soaring inflation.

The decision came after a split vote at the Federal Reserve’s two-day FOMC meeting scheduled for September 17-18 and led to the central bank lowering its benchmark interest rate to a new range of 4.75% to 5.0%. Interest rates have been at the upper 5.5% level for more than a year, since July 2023, the highest level in more than two decades.

“Recent indicators suggest that economic activity continues to expand at a solid pace. Job growth has slowed and the unemployment rate has risen but remains low,” Chairman Powell said. “Inflation has made further progress toward the (FOMC) 2% target but remains somewhat elevated.”

Inflation slowed for 2024 as a whole. GDP grew by an annualized 2.2% in the first half of the year, and the data suggest a similar pace of growth this quarter. Chairman Powell made clear that the economic outlook is uncertain, with the FOMC noting risks to both sides of its dual mandate of maximizing employment and keeping inflation low.

“In light of 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 percent,” he said at a news conference in Washington. “The committee will carefully evaluate incoming data, the evolving outlook, and the balance of risks as it considers additional adjustments to the target range for the federal funds rate.”

That could mean more rate cuts in 2024 and perhaps even 2025. In assessing its next rate move, the Fed will consider a wide range of information, including labor market conditions, inflation pressures and expectations, as well as financial market conditions and international events.

What does this mean for small businesses?

Interest rate cuts could lead to increased appetite for loans among traditional lenders, as lower interest rates help rebalance their portfolios. That could result in more borrowers qualifying for bank loans, which typically come with more favorable interest rates than those offered by nonbank lenders.

Lower interest rates will lead to lower interest rates for small business owners. Most small business loans are variable-rate loans, and the steady stream of rate hikes initiated by the Fed has made it more expensive to repay the loans, hurting their profits. Lower interest rates for businesses should positively impact their profits in the short term. In turn, mortgages are often fixed-rate, which protects homeowners from the cost of rising interest rates.

In addition, lower interest rates will lead to lower interest payments for consumers, which should help improve the country’s overall economy. Consumers are hurting badly because of all the credit card delinquencies and record delinquencies on auto loans.

During a press conference, Chairman Powell said the U.S. economy is in good shape; it is growing at a solid pace, inflation is falling, and the job market is strong. That is good news for small business owners whose income has been hurt by inflationary costs as well as high interest rates over the past two years.

However, caution is needed: while lower interest rates may support short-term earnings, their longer-term impact on the economy and potential structural changes remain uncertain.

The Fed’s decision to cut interest rates is seen as a gamble, and the coming months will show whether it will lead to a soft landing or a more significant impact on the economy. Inflation is driven by many factors, and the outcome will depend on whether the growth in the money supply leads to higher core inflation or whether core inflation remains unchanged. The Fed will no doubt assess the effectiveness of the rate cuts and their impact on the economy in the coming months to make adjustments accordingly.