At the central bank's annual retreat in Jackson Hole in August, Federal Reserve Chair Jerome Powell indicated plans to cut the federal funds rate when the Federal Open Market Committee meets next Sept. 17-18. This will be the first rate cut in more than four years following a series of aggressive rate hikes—11 over the span of a year and a half—aimed to tame inflation. 

The last time rates fell was in March 2020 at the outset of the pandemic when the Fed held an emergency meeting, bringing rates near zero. The federal funds rate is currently set at a 23-year high of 5.25-5.5%.

As inflation has cooled, the effect of high rates has become more pronounced. The “real” federal funds rate, when adjusted for inflation, is the most restrictive it’s been in nearly two decades, raising fears that the Fed may be behind the curve in responding to a slowing economy, just as it was slow to raise rates in response to inflation. 

The Federal Reserve is once again approaching a moment of truth. Can they stick the elusive “soft landing” in the economy—where growth slows but avoids a recession? Here’s what lowering rates might mean for the economy: 

Borrowing will cost less. When the Fed lowers the federal funds rate, it becomes cheaper for banks to borrow, leading to a drop in interest rates across different loan types. Expect better deals on interest rates as lenders compete for low rates.  

The housing market could improve. A silver lining of the recent market repricing is that mortgage rates are back to their lowest level since early 2023. Average rates on 30-year fixed rate mortgages have dropped more than 1% in the last few months, and some rates on 15-year fixed rate mortgages are back below 6%. A rate cut could help further thaw a housing market frozen by high mortgage rates and ease the burden on home buyers.

Spending may pick up. Retail sales grew 1% in July, the biggest monthly increase since early 2023. A monthly rebound in auto sales accounted for much of the jump but, even when excluding cars and gas, retail sales beat expectations. Lower interest rates may encourage consumers to finance big-ticket items like cars and homes, boosting demand for goods and services.

The job outlook remains uncertain. The latest jobs report forced investors and analysts to revisit their assessments of the economy. In July, hiring fell sharply and the unemployment rate ticked up for the fourth consecutive month. While 4.3% unemployment is low compared to long-term levels, unemployment can increase quickly in a deteriorating economy. By lowering the benchmark rate, the Fed hopes to encourage businesses to grow and hire new workers, keeping the job market strong. 

Some prices could remain sticky. Inflation fell below 3% in July for first time since 2021. Food and energy prices have been slowing, with motor fuel prices dropping 2.3% nationally and 6.7% regionally over the past year. But other price categories remain sticky. Housing price growth, while moderating, is still too high at 4.4%. And service sector prices continue to grow too fast, rising 4.9% over the last year. Impending rate cuts will do little to relieve this price stickiness, absent a recession.  

The U.S. dollar may weaken. Traveling abroad may get more expensive following a rate cut. While rising interest rates generally strengthen the U.S. dollar, falling rates tend do the opposite. A weaker dollar means international travel will cost more. 

The Fed will meet three times before the end of the year, but don’t expect to see interest rates drop to the historically low levels of recent years. While inflation is slowing, it remains above the Fed's preferred rate of 2%. The debate is now whether the Fed should shift its focus from maintaining price stability to supporting the labor market.