Wednesday, August 14th, 2024
Anticipating the Fed’s Move
The last time the Federal Reserve increased interest rates was over a year ago, during its July 2023 meeting. Since then, economists and market analysts have been closely watching for signs of rate cuts. At Navalign, during our annual client event at the beginning of 2024, we projected that the Fed would cut rates up to two times this year, with the first cut expected in the second half of 2024.
The Federal Reserve’s most recent meeting in July 2024 left rates unchanged. However, the market is now more certain than ever that rate cuts are imminent. According to Fed fund futures markets, there is a 100% chance that rates will begin to decrease starting with the upcoming Federal Reserve meeting in September 2024.
How Rate Cuts Affect Different Investments
When the Federal Reserve lowers its key short-term interest rate, known as the federal funds rate, financial markets often react, but the impact varies across different investments. Here’s a look at what historically happens to various parts of the market when rates are cut.
Short-Term Impacts
Cash Investments
- Impact: Negative
- Explanation: Yields on cash investments typically fall. This includes various cash-related investments, such as money market funds and short-term Treasuries.
Certificates of Deposit (CDs)
- Impact: Negative
- Explanation: CD rates often decline, but the extent can vary across CDs with different maturities.
Savings Accounts
- Impact: Negative
- Explanation: Bank savings rates generally decrease gradually following a rate cut.
Stock Market
- Impact: Uncertain
- Explanation: Initially, stock markets may welcome a rate cut as a counterbalance to slowing economic growth. However, if the slowdown turns into a recession, markets tend to decline after the initial rate cut.
Financial Stocks
- Impact: Negative
- Explanation: A shrinking gap between what banks pay on deposits and charge on loans can hurt bank stocks.
Utilities Stocks
- Impact: Positive
- Explanation: Utilities stocks, which typically pay steady dividends, tend to outperform as investors shift away from lower-yielding fixed-income investments.
Adjustable-Rate Mortgages (ARMs)
- Impact: Positive
- Explanation: Rates on ARMs, which are usually tied to short-term rates, can be expected to fall.
Auto Loans
- Impact: Positive
- Explanation: Auto loan rates, often tied to short-term rates, may fall. However, these rates can vary depending on sales incentives and other factors.
Home Equity Loans
- Impact: Positive
- Explanation: Rates on home equity loans usually track short-term interest rates and may move gradually lower.
Short-Term Bonds
- Impact: Uncertain
- Explanation: Initially, short-term bond prices may rise. However, as existing bonds mature and proceeds are reinvested into new, lower-yielding securities, the income they generate declines over time.
Intermediate-Term Impacts
Intermediate-Term Bonds
- Impact: Uncertain
- Explanation: These bonds are usually more sensitive to interest rate changes, so their price gains may be greater than for bonds with shorter maturities.
Asset-Based Loans
- Impact: Uncertain
- Explanation: Rates on loans such as pledged asset lines and margin loans may fall gradually.
Federal Student Loans
- Impact: Uncertain
- Explanation: The annual rate on federal student loans is based on the Treasury Department’s auction of 10-year notes in early May, and 10-year yields are influenced more by growth and inflation expectations than by changes in the federal funds rate.
Global Stocks
- Impact: Positive
- Explanation: International stocks generally outperform U.S. stocks during rate-cut cycles.
Long-Term Impacts
Long-Term Bonds
- Impact: Uncertain
- Explanation: While longer-term bond prices may initially rise, over time they are more affected by growth and inflation expectations than by the federal funds rate.
Mortgage Rates
- Impact: Uncertain
- Explanation: Fixed mortgage rates generally track 10-year Treasury yields, so a lower federal funds rate won’t necessarily drive mortgage rates lower over the long-term, but in the short-term this may cause mortgage rates to trend lower.
As we anticipate the Federal Reserve’s potential rate cuts, it’s essential for investors to understand how these changes might impact their portfolios. While certain investments may benefit, others may face challenges. Diversification and a long-term perspective remain key strategies in navigating these changes.