When Will Interest Rates Go Down? A Historical Look at Fed Policy

The Federal Reserve building.

Higher interest rates have been a mixed bag for the business community over the past two years. Whether your business has experienced higher borrowing costs or better investment returns, the future of rates is sure to be of great importance.

Federal Reserve Chairman Jerome Powell recently announced that interest rates may have peaked. Now, Americans have turned their attention to predicting the timing of the first rate cut.

How soon will interest rates fall?

The most recent projections from the FOMC show 3 interest rate cuts this year – which would bring the Fed Funds Rate to a target range of 4.5 – 4.75%. Interest rates are expected to decline further over the following two years before reaching a long-run average of 2.5%.

While the FOMC hasn’t given a specific timeline for rate cuts, analysts have already begun to record their forecasts. A small percentage of these analysts predict the first interest rate cut will occur at the January 2024 FOMC meeting. However, the majority anticipate it will come later in March with further rate cuts expected throughout the year. This timeline may seem aggressive considering inflation has not yet settled at the Fed target of 2%, but historical patterns show it to be comparable to past rate cutting cycles.

Historical Changes in Interest Rate Policy

There have been five major periods of interest rate hikes over the past three decades and each has been swiftly followed by rate cuts. The economic conditions that led to the rate changes have varied widely, but there are trends from these cycles that can help put the current situation in perspective.

Mid-1990s

The Fed raised interest rates by a total of 3.00% between February 1994 and February 1995 to combat high inflation. Higher interest rates were successful in cooling inflation and the Fed began lowering interest rates just 5 months after the last hike. Rate cuts lasted 6 months during which time the Fed reduced interest rates by a total of 0.75%.

Early 2000s

At the peak of the Dot Com Bubble, the Fed instituted another bout of monetary policy tightening – this time to prevent inflation. It lasted 11 months between June 1999 and May 2000 during which time the Fed raised interest rates by a total of 1.75%.

The bubble had begun to burst by January 2001, and the Fed reduced interest rates to combat weakening sales and low consumer confidence. The Fed slashed interest rates by an astounding 4.75% by December of that year.

Mid-2000s

After several years of mostly stable rates, the Fed began a series of gradual rate hikes in June 2004. Over the following 24 months, the Fed raised rates by a total of 4.25%.

The Fed began cutting interest rates in September 2007 – just 3 months after the last rate hike. Lower rates were intended to forestall the housing correction and weakening economic growth. Cuts continued through December of the following year when the Fed Funds Rate fell to the lower bound – a target range of 0 – 0.25%. Overall, the Fed reduced interest rates by 5 – 5.25%.

Late-2010s and Early 2020s

The Great Recession was so devastating that it took seven years for the Fed to raise interest rates from the lower bound. The first hike was in December 2015 and rates continued to rise for three years – during which time the Fed raised rates by a total of 2.25%.

The Fed began reducing interest rates due to a projected economic decline in August 2019 – eight months after the last rate hike. Two more rate cuts in 2019 brought the Fed Funds Rate to a target range of 1.50 – 1.75%. Then, the COVID-19 pandemic and subsequent recession began, and the Fed quickly cut rates to the lower bound in March 2020 to spur economic activity.

The Current Era

Following the COVID-19 pandemic, the United States was in a unique economic position which led to the fastest pace of inflation since the early 1980s. The Fed responded with a decisive series of interest rate hikes that spanned the 16 months between March 2022 and July 2023 and raised the Fed Funds Rate by 5.25%. Now, the Fed signaled that interest rates may be at their peak, and Americans have turned their attention to the timing of rate cuts.

Lessons From Past Interest Rate Cycles

It is difficult to draw conclusions from past monetary policy actions because the economic conditions surrounding each decision were unique. However, there is one commonality that stands out – each period of rising interest rates was followed by a rate cut within a relatively short time.

The shortest time between a tightening cycle and the first interest rate cut was during the Great Recession, when the Fed waited only 3 months before reducing interest rates. The longest pauses before a rate cut were in 2001 and 2019 when the Fed waited 8 months before lowering interest rates.

In the current tightening cycle, the estimate of an 8-month lag between the last interest rate hike and a March rate cut is in line with historical patterns. However, there are still uncertainties surrounding the future of interest rates. Inflation, geopolitical turmoil, and the economic outlook could all influence the Fed’s decisions and the future of interest rates.

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