Interest rates often get an outsized amount of attention because they touch nearly every corner of economic life. From mortgage costs and credit card interest to portfolio returns and the yield on your savings, interest rates play a central role in shaping financial conditions. Adjusting those rates falls under the purview of the Federal Reserve.
In recent months, the Fed has taken a cautious stance, holding interest rates steady despite growing pressure from President Trump. Following its July meeting, Jerome Powell and the Fed left rates unchanged once again, though the stage has been set for rate cuts later this year – likely at the mid-September meeting – and there are already talks about who might eventually replace Powell as Fed Chair. With these headlines swirling, we want to revisit a question we periodically hear from clients: why does the Fed raise or lower rates, and what implications does this have for my portfolio?
The Fed’s Dual Mandate
To better understand the Fed, we first have to understand what’s known as its “dual mandate”: promoting price stability and maximum employment.[1] Price stability refers to the goal of keeping inflation in check, while maximum employment refers to ensuring that labor market conditions support broad-based job opportunities. These two objectives guide the Federal Reserve’s policy decisions and are intended to foster sustainable economic growth.
Unsurprisingly, the two goals are intertwined. If inflation rises too rapidly, household costs can quickly outpace income growth and destabilize the economy. On the other hand, high unemployment typically leads to lower consumer spending and business investment, which can also destabilize the economy. Adjusting interest rates is one of the Fed’s primary tools for managing these dynamics and maintaining balance in the US economy.
Why Does the Fed Lower Rates?
The Fed typically lowers interest rates when economic growth slows or the risk of recession increases. Lower rates reduce the cost of borrowing, encouraging businesses and consumers to spend and invest. For businesses, lower rates mean more affordable financing for projects, equipment, or hiring. For households, they can reduce monthly payments or make mortgages more accessible.
This boost to economic activity is intended to help mitigate the effects of an economic downturn. We saw this after rates hit their most recent peak in 2023 and the economy showed some signs of slowing, leading the Fed to pivot and lower rates three times during 2024. This year, inconclusive data regarding inflation, employment, and the potential effects of Trump’s tariffs have led to caution about further cuts.
Calls to reduce interest rates often grow louder in periods of uncertainty, such as during trade tensions, geopolitical instability, or uneven global growth… sound familiar? Political leaders may be advocating for cuts to stimulate short-term gains, but the Fed generally waits until new economic reports are released to confirm any rate decisions. This more cautious approach means that rate changes may lag current economic reality, but it also means that they are grounded in verified data rather than more subjective projections abut economic trends.
When Does the Fed Raise Rates?
Conversely, the Fed raises rates when inflation threatens to rise too quickly or the economy shows signs of overheating. Higher interest rates help to temper demand by making borrowing more expensive. This tends to reduce spending and investment, which in turn reduces or at least slows down broad inflation.
Leaving interest rates too low for too long introduces other risks. Chief among them is the formation of asset bubbles, where valuations of stocks, real estate, or other assets become detached from underlying fundamentals. Sustained inflation is another risk, and once entrenched, it can be difficult to reverse without sharp policy interventions.
A recent example occurred in the aftermath of the pandemic when rates were at an all-time low and inflation began surging well beyond the Fed’s 2% target. This led the central bank to raise interest rates 11 times between 2022 and 2023.[2] Although this tightening cycle caused price declines in both equity and fixed income markets, it was instrumental in reining in inflation and restoring a sense of balance and normalcy to the economic landscape – and ultimately setting the stage for the next cycle of growth.
How Rate Changes Affect Everyday Life
When we look closely, we can see that changes in interest rate policy influence many aspects of our financial lives. Mortgage rates, credit card interest, and auto loans often move in response to Fed policy. Lower rates may encourage refinancing or new purchases, while higher rates often incentivize debt reduction.
Savings rates respond as well. When rates rise, banks tend to offer more attractive yields on savings accounts and CDs, benefiting conservative savers. When rates fall, the return on cash holdings typically declines, reducing the incentive to hold large amounts in savings.
Interest rate changes also influence market behavior. Lower rates tend to support higher equity prices by reducing corporate borrowing costs and increasing the relative appeal of stocks compared to bonds. Higher rates may weigh on equity valuations but can enhance opportunities in fixed income, particularly as yields rise. While these trends are worth understanding, short-term rate movements should not drive major investment decisions.
Staying Focused on the Big Picture
While politicians and media coverage may amplify rate-related headlines, these decisions have historically been grounded by the Fed’s mandate and economic data rather than external pressures. Similarly, our North Berkeley client portfolios remain grounded in diversification and personal goals around earning, spending, and building financial resiliency rather than external factors such as market timing.
The key is to remain focused on the broader view and a longer time horizon than any current political landscape. Interest rate decisions are just one part of a much larger economic picture. Staying committed to long-term goals, a diversified portfolio, and sound planning remains the most reliable path toward lasting financial security.
Resources:
[1] The Fed and the Dual Mandate | In Plain English. St Louis Federal Reserve
[2] Federal Funds Effective Rate from 1954-2025. St Louis Federal Reserve
