Fed Makes a Move: First Rate Cut Since 2020 Signals Economic Shift

This week, the Federal Reserve’s Federal Open Markets Committee (FOMC) decided that its target policy rate range would decrease by 50 basis points, resulting in a new target range for the Federal Funds Rate of 4.75 percent to 5 percent. Between March 2020 and July 2023, the Fed increased the rate 11 times. This is the first rate reduction since March 2020. Chairman Jerome Powell noted the Fed’s patient approach leading up to the Fed’s current decision as it monitored inflation data. The Fed’s method going forward will continue to be data-driven though, there now seems to be a clear consensus within the Fed for future reductions based on future inflation expectations and a desire to control unemployment.

Chairman Powell reinforced the Fed’s dual mandate with a current belief that employment will continue to stay strong. The Chairman also noted that the Fed is continuing its balance sheet reduction program, commonly referred to as “quantitative tightening.” Bond and other credit markets have for some time been factoring in a rate cut of one degree or another, and these markets now appear to be factoring in further rate cuts before year-end. For the longer term, the Chairman noted that a poll of Federal Reserve board members projected a Federal Funds Rate of 4.4 percent at the end of 2024 (a further decrease of 50 basis points) and 3.4 percent at the end of 2025 (a further decrease of 100 basis points).

• This week's reduction has been a long time coming, with many having predicted (or hoped for) multiple rate cuts in 2024.
• Secured and unsecured rates are expected to continue their recent downward trajectory, bringing additional relief, and planning opportunities, to a range of borrowers and issuers.
• Reducing rates should certainly help increase overall commercial real estate deal activity which will likely include an uptick in refinancings and sales, as well as an uptick in distress-related transactions and resolutions as the commercial real estate market looks to clear and reset a back log of troubled legacy transactions.
• Notwithstanding declining rates, constrained capital and reduced valuations will continue as factors affecting new and existing deals across a range of markets with alternative capital providers looking to fill gaps in deal structures.
• Borrowers hedged with a swap should look at where their fixed rate is set. If the new rate is less than the fixed rate, the borrower may be required to make settlement payments or collateral deposits. Meanwhile, borrowers hedged with caps may have opportunities to sell existing caps with higher strike prices and purchase replacements for less premium.
• Investors with fixed income portfolios might consider monetizing marked-to-market portfolio gains as their fixed-rate instruments acquired during the higher rate environment become more valuable as interest rates decline.
• Treasurers may want to stress test their portfolios to see how they will perform at various points of rate reduction. In particular, certain banks were at risk in rising markets as they had significant amounts of fixed rate instruments that were not marked to market. Treasurers with significant floating rate assets may want to review their portfolios to ensure sufficient liquidity and capital. 

Lawyers in Ballard Spahr’s national Finance Department and Distressed Assets and Opportunities Group advise clients across a wide range of public and private debt and equity transactions throughout the capital stack, and related transactions including; hedging and derivative transactions, and distressed restructuring and enforcement matters. Please contact us if you have questions or would like to learn more about the team. 

Need a refresher on rate setting? Click here for our primer. 

Read our past Alerts on private credit and distressed office buildings.

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