The Fed will release its interest rate decision on Wednesday, with the market expecting a 25 bps cut to kick off the next cycle of lower rates. While a lower rate generally benefits the economy by making it cheaper to borrow capital, it also can carry downside risks if done improperly.
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First, higher rates combat inflation by slowing consumer spending and business investment. If inflation were to increase following a rate cut, the central bank could potentially be forced to backtrack and raise rates again.
A Rate Cut Could Reflect a Cooling Labor Market
Furthermore, a rate cut can signal that the economy is slowing down. That’s been reflected in recent labor market data, as seen in August’s nonfarm payrolls report that showed just 22,000 job additions compared to the estimate of 75,000.
“The Fed is often observing a slowdown in growth, and cuts are not a freebie,” said Fixed Income Resources founder Charles Urquhart in an interview with Quartz. “Consumers might mistake ‘cheaper borrowing’ for a ‘strong economy.'”
Overall, Tuesday’s rate cut decision will set the tone for the rest of the year, influencing borrowing costs, sentiment, and the economic outlook.
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