If you’re anything like us, sometimes you hear about certain things and pretend to know what they are for the sake of conversation when, in reality, you have no idea what they are. Interest rate cuts feel like one of those things. With the Federal Reserve cutting interest rates by half a point back in September and signaling that more cuts could come throughout the latter half of the year, many of us are turning to Google to understand why this is such a big deal. This is only exacerbated if you’re a business owner, as you need to know how this will impact you personally and your business.
Luckily, Payday HCM is a company with extensive experience—enough to give Google a run for its money when it comes to finding answers to questions (at least as it concerns interest rate cuts, maybe not whatever else you may be googling). We work with many small businesses who ask us what they can expect with the FED’s interest rate cuts and how they might impact their business.
In this article, we’ll go over everything you need to know about interest rate cuts and how these actions impact your business. We’ll look at all the different areas that might be affected, including things like hiring and business spending. We’ll also go over the different things you should expect, whether you’re just starting out or have a well-established business. By the end, you’ll be ready to face the future economic landscape with confidence.
In this article, you will learn:
- What Are Interest Rate Cuts And How Do They Work?
- How Interest Rate Cuts Impact Businesses
- How To Make The Most Of Interest Rate Cuts
What Are Interest Rate Cuts And How Do They Work?
Before we dive into how interest rates can affect your business, we first need to understand what they are and how they work.
What Are Interest Rate Cuts?
When people talk about the Federal Reserve raising or lowering interest rates, the thing that people are actually talking about is the federal funds rate. According to the Federal Reserve, the federal funds rate is the interest rate that is applied to financial institutions when borrowing or loaning money overnight.
Banks and financial institutions do this in order to meet the reserve requirements outlined by the federal government. So, in the middle of the night, the banks that need money ask the banks that have too much money if they can have some. The banks with lots of money agree, but since it’s a loan, there’s gonna be some interest. That interest is the federal funds rate.
When we talk about the Federal Reserve raising or lowering interest rates, it’s slightly misleading as the FED doesn’t necessarily actually “set” the rate. Instead, the FED sells or buys government bonds (in other words, it takes or gives banks money) in order to raise or lower the federal funds rate.
So, when the Federal Open Market Committee meets eight times a year, they determine whether the federal funds rate should be higher or lower— the federal funds target rate. They then buy or sell government bonds to reach this target rate (or do nothing if they decide to leave the rate where it’s at).
How Do Interest Rate Cuts Work?
As discussed above, when the FED decides to lower the federal funds rate, it actually buys government bonds from financial institutions. The goal is to encourage spending, both by consumers and companies.
This manifests in a few different ways. First, the cutting of interest rates lowers the prime rate. According to the Federal Reserve, the prime rate is a reference point that banks use to determine the interest rate on everything from small business loans to credit card loans.
These moves can also impact the stock market as stocks tend to spike higher following an interest rate cut. These cuts can also impact other longer-term loans like mortgages or auto loans, but depending on the size of the cut, these impacts can be harder to see.
How Interest Rate Cuts Impact Businesses
Now that we better understand how interest rate cuts work, we’ll explore what these cuts mean for your business.
It’s Time To Spend
The largest impact businesses can expect from interest rate cuts involves spending. Well, perhaps to put it more accurately for whoever is reading this article, the FED hopes that, by cutting interest rates, you, as a business owner, will be more likely to spend.
This makes sense, though: the lowering of interest rates means that businesses can access more capital at lower rates, making dreams of expansion a more plausible reality. In fact, a survey performed by CNBC and SurveyMonkey just prior to September’s rate cut found that business owners would be more likely to increase investments in expansion given an interest rate cut.
So, should you spend? Well, a lower federal fund rate can encourage you to do so, as it is aimed at lowering interest rates for businesses and consumers alike. These kinds of cuts can be especially beneficial for those looking to start a business. According to Forbes, a notable increase in tech startup activity took place when the FED slashed rates in 2020, just as an example.
More Hiring On The Horizon?
While the FED’s strategy surrounding interest rate cuts over the past few years has largely been guided by inflation, September’s cut also showcases another factor that can motivate the FED to make these kinds of moves: hiring.
Prior to the half-point cut, the job market was entering a noticeably cool period. According to The New York Times, only 142,000 new jobs were added in August—a far cry from the estimates. This, in a way, makes sense: the FED was using a 5 percent interest rate in an attempt to cool inflation. This would discourage business spending and, in turn, decrease hiring.
But how does the federal fund rate affect hiring? Again, it’s all about spending. With interest rate cuts, businesses can access capital at lower rates, encouraging expansion. This largely translates to businesses bringing on more employees. According to Reuters, the FED’s most recent cuts will allow one small business owner to hire around 50 seasonal employees.
How To Make The Most Of Interest Rate Cuts
Now, how do you navigate these changes in interest rates? First, we’ll look at what businesses can expect from higher interest rates to get a better idea of how to take advantage of lower interest rates.
What High Interest Rates Mean For Businesses
Prior to the FED’s September cut, many economists and analysts were hoping for some sort of indication that the FED might make those cuts sooner. Why? The downsides that high interest rates can have not only on consumers, but businesses as well.
According to Forbes, high interest rates lead to, most obviously, higher borrowing costs. However, they can also lead to decreased consumer spending, issues with cash flow, and stunted growth. Of course, high interest rates do serve their purpose (lowering inflation), but that comes with a trade-off, much like lowering interest rates has its own trade-offs (increasing inflation).
Best Practices With Lower Interest Rates
When it comes to your business, you want to be smart with your money. That’s probably the reason why you’re reading this article. Then, if higher interest rates can create an economic tightening—generally lowering spending across the board—then lower interest rates present the opportunity to do the opposite.
For businesses, this can involve potentially long-delayed expansion opportunities or refinancing higher-interest loans. You also have the potential for increased cash flow from increased consumer spending, which will only further your ability to grow and expand. Now would be a good time to fill that position that’s been vacant for oh so long.
Of course, you’ll want to do all of these things within reason. You’ll still want to be prepared for the times when interest rates go back up. Again, the FOMC meets eight times a year, meaning you’ll need to be prepared to operate during all eight of those potential changes.
Cut Out The Fear Of Economic Uncertainty
Economic changes can be challenging to handle. Not only are you tasked with navigating your business through potentially treacherous waters, but you also need to understand what is actually going on in order to do that. You may find yourself blowing the dust off that dictionary you got as a graduation gift from that one relative you only see once every five years, but even then, you might still be at a loss. The FED’s raising and lowering of interest rates can be one of those topics. Now, though, you have all the knowledge you need to navigate these sometimes confusing issues.
As discussed earlier, lower interest rates can be a good sign for those looking to start a new business. The things discussed in this article, though, aren’t all you need to know. From here, it’s important that you read our sister article on something that’s nearly just as exciting (and important) as interest rates: taxes.
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