What Interest Rate Drop Means for Small Businesses
WASHINGTON, DC — Federal Reserve Chair Jerome Powell announces on Dec. 18, 2024, that the Federal … [+]
The Federal Reserve’s Federal Open Market Committee (FOMC) voted to cut interest rates again on Wednesday, December 18, by lowering the target range for the federal funds rate by 1/4 percentage point (25 bps) to the 4 1/4 to 4 1/2 percent range.
The committee reported that recent indicators suggest that economic activity has continued to expand at a solid pace. Since early this year, labor market conditions have generally eased, and the unemployment rate has moved up, but still remains low. Importantly, the economy has made progress toward The Fed’s target 2% long-term inflation rate, but inflation still remains somewhat elevated.
With an uncertain economic outlook, the FOMC is attentive to the risks to both sides of its dual mandate of full employment and the 2% goal.
The biggest reason why the Fed has cut the interest rates is that overall inflation numbers look better. Obviously, there was a lot of expectation in the markets that the FOMC would come up with this interest rate cut, and they did just that. The Jobs Report earlier this month was pretty weak, so that also justifies this third consecutive rate cut.
Related: Why The Fed’s Lower Rates Will Boost Small Business Earnings
In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Fed indicated that it will carefully assess incoming data, the evolving outlook, and the balance of risks. Since September, the federal funds rate has dropped a full point from its peak. This is a relatively big drop in the short period of time. The FOMC must seriously consider whether future rate cuts in 2025 might contribute to increasing the rate of inflation. The vote was not unanimously approved; this latest reduction was approved by 11 of 12 FOMC voters.
Related: With Rate Cuts Likely, Businesses Should Prepare Now To Borrow
One thing to keep in mind is that inflation, at just under 3%, is still almost 50% higher than its target rate. It remains sticky.
While this is happening, banks are having a tough time making money on loans. They are paying more for their deposits, which are becoming harder to attract. Meanwhile, the Fed wants to help banks make loans to small businesses, which create the lion’s share of private sector jobs in the economy.
NEW YORK – President-elect Donald Trump rings the opening bell on the trading floor of the New York … [+]
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As we enter 2025 and the Trump Administration returns, the Fed will continue to monitor the implications of incoming information for the economic outlook. A problem in 2024 was inaccurate reporting of job creation in the economy. Months after they were reported, the Bureau of Labor Statistics revised its job creation figures significantly downward. It’s unclear – or at least unproven – why they overstated the number of new jobs in the economy during the early part of the year.
How Should Small Businesses Plan for 2025?
Small business owner plans for 2025 depend on two or three things. Obviously, the Trump administration is coming in, and it will be much more business friendly. Already, we have seen there has been a big spike in the confidence of small businesses in the country.
However, inflation is still a challenge. Chair Powell said that if we see inflation starting to go up again, the Federal Reserve won’t be able to cut rates easily.
However, any business owner who has growth plans and is looking to borrow money, it’s a better time now than at any other time in the last two and a half years. With rates already down by 1 percent, SBA loans are now the cheapest they have been since the pandemic and companies that already have outstanding loans with variable rates will get immediate cash flow benefits from these lower rates.
Business owners should take a wait-and-see attitude as to how they plan for the new year. They should look at how the first half of 2025 pans out. Looking at the data, 2025 could be pretty tough initially. Things should get better in the latter half of the year.
The impact of interest rate reductions will help small and mid-sized banks, which had big exposure in commercial real estate because their portfolios were at fixed rates. As interest rates come down, the market values of the portfolios will improve, which provides relief for them, since they have suffered a lot over the past two years.
As more capital frees up, I expect that lending activity will increase next year. Additionally, I foresee an increase in bank mergers and acquisitions in 2025. Further, we will likely see banks streamline their branch networks to lower their fixed costs. All of this bodes well for small business lending.
For business owners who are looking to expand, now could be the right moment to add capacity or acquire another company as interest rates have been cut during the past three FOMC meetings. It will be important to keep fixed costs (rents, mortgages, equipment, vehicles, etc.) manageable, since they are tough to adjust. Variable costs, such as the number of staff and the number of hours they work, are easier to alter. The important thing for the new year is to build a business that is efficient.
