If you’re unfamiliar with the power of a Federal interest rate cut, picture this: borrowing money becomes cheaper, mortgages become more affordable, and businesses can expand more easily.
That’s the power of a rate cut.
And recently—on September 18, 2024—the United States Federal Reserve cut interest rates by a half-percentage point, or in Federal Reserve parlance fifty basis points, or 0.5%.
So what does this mean for you? Where will your investments be impacted? What should you expect, in general, in regard to inflation prices? And how can you capitalize on any potential leverage you might have?
Let’s break down how the Fed’s decision to cut interest rates will ripple through the economy and potentially impact your investment portfolio.
This is the first rate cut we’ve experienced in four years.
During the pandemic, we experienced historic financial volatility in the economy. So the Federal Open Market Committee (aka: The Federal Reserve — aka: The Fed) decided to cut interest rates in an effort to keep businesses borrowing and the economy flowing.
Fast-forward to the end of 2021, though, and we started to see extreme inflation. At first they called it transitory, meaning it was only affecting a few different goods within the economy. (You probably remember construction prices skyrocketing, particularly for wood). Across the board, it wasn’t too bad—until it got bad. That’s when inflation hit our grocery runs, restaurant bills, and retail receipts. At that point, it started to get away from The Fed.
Why Now?
Basically, the Federal Reserve has a dual mandate. It has two things to keep in check: price stability (inflation) and unemployment rates.
The inflation target is 2%. At one point over the past four years, it hit 8%. We’ve come down significantly since then—to around the 2.5% range. That’s a good thing.
The unemployment rate target is between 2.5% to 4%. The US is hovering just over that 4% benchmark right now. Over the past few months we’ve seen this number starting to trend higher, which is in large part why we are seeing The Fed make these interest changes.
If both these items are within their accepted values, The Fed deems it a “healthy economy.”
With all that said, The Fed’s goal is to adjust rates up when they want money to be harder to get (or more expensive to borrow for) and down when they want money to be easier to get (cheaper to borrow for).
By cutting rates on September 18th, they’re trying to make it easier for folks and businesses to get (borrow) money. Likely because the high interest rates curbed inflation and unemployment rates enough to appeal to their standards.
The half-percent cut was a bit of a surprise, though.
Normally, The Fed cuts rates by a quarter percentage. The jump to a half-percent is significant because it suggests they want to be aggressive about future rate cuts.
If we remember, their rate increases in recent years were extremely aggressive. In fact, it was the fastest rate increase in modern economic times. We’ve never seen anything like it. This triggered some significant challenges for the stock market, the bond market, and with both commercial and regional banks.
The rate increases slowed the economy significantly.
Of course, now that the rates are coming down again, it suggests a desire to increase growth and stimulate the economy. In my opinion, this motive is more likely than cutting rates to stave off some kind of economic crisis. Especially considering that inflation and unemployment rates are stabilizing a bit.
So what does this mean for you?
Now we’re getting to the good part, right? Let’s take a look at what all of this means and what kind of impact it might have on your life.
Mortgage Rates Will Be Reduced
This is a pretty fair assumption. We often see a trend between mortgage rates and the 10 Year Treasury rates, though they’re not directly tied together. But the general rule-of-thumb is to take the 10 Year Treasury rate and add 2—that’s where you’ll usually see mortgage rates land.
Recently, the 10 Year dipped just below 4%. Mortgage rates are hovering around 6%, which checks out. What’s interesting is that during August and early September we already started to see mortgage rates drop. When rates were eventually cut, there wasn’t a dramatic movement in rates because the impact was already “baked” in.
With this, we’re also seeing prime rates—or the interest rates banks use on credit cards, loans, and lines of credit—come down. That lowers the cost to borrow for everyone. Lower floating rate loans, like Home Equity Lines of Credit (HELOCs), will have a big impact on consumers.
Real-Estate Market Will Likely Move Faster
The real-estate market—residential and commercial—will likely benefit from a rate cut.
Within the residential world, when you see lower mortgage rates, you usually see more folks who are willing to sell. Why? Because homeowners who were locked into a low rate at their time of purchase—before rates climbed—don’t want to lose their rate. If they get a new house, they’d have to take on higher interest. How much ‘extra house’ does that actually give you?
We’ve been stuck in this environment for the last couple of years where people have been locked into a really good interest rate, so they don’t want to move.
This impacts supply, right? Now the idea is that if more folks are willing to sell, buyers gain a little more advantage than they’ve had recently. Not to mention, buyers who have been turned off by high interest rates will be motivated to turn on their real estate app notifications now that they’re coming down.
So, buyer demand is likely to rise and sellers will be more likely to sell.
In terms of commercial real-estate, which impacts more of the investor world, you’ll see lower borrowing costs. This should bring more investments back into buildings. There will be more opportunities for updates and renovations, which will bolster the value of commercial property.
This could encourage more investment. Interestingly, with the significant challenges in the commercial real estate market, the rate cut could be seen as a lifeline for those trying to refinance the debt of distressed buildings. We have already seen some pretty steep discounts on building prices over the past few months.
Money Markets Could Shift Down
Money market funds are tied to short-term debt instruments, which include floating rate funds, treasury bills, and the cash-oriented CDs. Right now, the average money market funds are generating about a 4-5% return. This is a terrific place to be, considering that between 2009-2020 or so, money markets were hardly generating any type of return.
To see money market funds, which are relatively low risk, generating up to a 5% yield is pretty significant. However, with rates getting cut, those 4-5% interest rates are likely to go down. This might make holding cash in a money market fund less attractive.
This opens the conversation around where to invest if you want to move money out of cash.
Where should you look to invest?
Bonds are about to be a hot topic.
Over the last 3 years, we’ve seen extreme volatility in the bond market. 2022 was probably one of the most volatile years for the bond market as a whole.
It was a time when people were calling the 60/40 portfolio (60% stocks and 40% bonds) dead.
Because while generally a 60/40 portfolio is a safer investment strategy, the instability within the bond market made it far less so. In 2022, bonds were down almost 15%, which was a dramatic shift. It no longer felt like a safe investment strategy.
Cut to today: we’ve seen a little recovery from the bond market. And remember, bonds are highly impacted by interest rates.
That’s because the rates dictate what kind of interest rate you can receive from a bond. In a rising interest rate environment, as we saw in 2021 into 2023, we saw an unstable bond market with a lot of price fluctuations during that period of time..
For clarity and education, price and interest rates work inversely in bonds. So when rates go up, bond prices go down. So, when rates get cut, longer maturity bonds tend to be more attractive.
At Four Points Wealth, one of the strategies we’ve had for the last few years, is to have shorter duration—or shorter maturity—bonds. This means they’re not going out to the 30-year level. They’re less than 10-years, on average.
That’s helped maintain stability in our bonds strategy.
But now that we’re seeing interest rates getting cut, it might be time to look at longer maturities of bond portfolios. Today, we’re still seeing a negative yield curve, where short term bonds pay more interest than longer term bonds. However, that trend is starting to flatten out.
During a normal cycle, the 10 or 20-year bond would have a higher interest rate than the shorter. So, we’re still in a wonky spot. We should tread lightly, but we are shifting from focusing on the shorter assets to longer ones.
Stocks are shifting in a way that could benefit us across the board.
Over the last few years, megacaps (stocks valued over $200 billion) like Nvidia, Apple, Amazon, Microsoft, and Tesla, have dominated the market. These huge companies have done much better than the rest of the stock market.
The industrials, utilities, banks, and the like, have lagged behind. But I’m also noticing that the megacaps have done a lot better than the small and mid-caps. This isn’t necessarily what you’d expect.
I think a large part of it is that during a rate climbing environment, the massive corporations have had enough market structure and cash-in-hand that they haven’t had to borrow much in order to keep their businesses expanding. Because of that, rising interest rates haven’t affected them much.
But now I think we’ll see an emphasis on growth across the board. However, this isn’t a greenlight for going full gas on the risk. I always like to remind investors to be cautiously optimistic.
When rates go down, it decreases a company’s borrowing costs. This allows them to move back into capital improvements and incorporate their capital expenditures back into their companies. That equates to more hiring power, the ability to take on more facilities, as well as invest in the technologies they’ve been sitting on while rates were high. Now might be the opportunity to grow.
Businesses might also decide to move out of cash.
Right now, cash is a great place to be. But as the value of investment rises higher, it’s likely that businesses will move some of their funds out of cash. This could be beneficial for stockholders and investors. Lower borrowing costs increase the opportunity for investment and growth within mid-to-small-range companies. We could see a lot of mergers and acquisitions and a whole host of other things that could happen.
The outlook is good here.
Where does that leave gold and silver?
I often get asked about gold and silver and precious metals. At Four Points Wealth, we don’t focus much on precious metals because they’re a commodity, so they tend to be pretty volatile.
That said, during a rate cutting environment, we might get a mixed bag. The way I’m looking at it is that the US rate cut is going to be less impactful on precious metals than the geo-politics happening right now. Considering what’s going on in the Middle East, the war between Russia and the Ukraine, as well as some of the challenges arising within China—these factors are likely to have more impact on gold, silver, and the like.
So, when it comes to interest rates, you may not see a massive shift in this arena.
It’s a lot to process, but it bodes well.
There’s a lot going on here, and a lot to consider when interest rates move. Thankfully, we tend to see a lot of benefit from the kind of rate cut The Fed recently enacted. If you’re thinking about how you might want to move your money—or how to establish your financial planning and investment strategies in light of this rate cutting environment—I highly recommend speaking with a fiduciary advisor. My team here at Four Points Wealth Management would be happy to help provide context to your situation. Set up an introductory call and we can walk you through our take on how to take advantage of this shifting economic landscape.
Four Points Wealth Management
DISCLOSURE
Advisory services are offered through CS Planning, Corp., an SEC registered investment adviser.
This Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained on our Site constitutes a solicitation, recommendation, endorsement, or offer by Four Points Wealth Management or any third-party service provider to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.
All Content on this site is information of a general nature and does not address the circumstances of any particular individual or entity. Nothing in the Site constitutes professional and/or financial advice, nor does any information on the Site constitute a comprehensive or complete statement of the matters discussed or the law relating thereto. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of any information or other Content on the Site before making any decisions based on such information or other Content.
In exchange for using the Site, you agree not to hold Four Points Wealth Management, its affiliates, or any third-party service provider liable for any possible claim for damages arising from any decision you make based on information or other Content made available to you through the Site.
