Our Thoughts on the Fed Rate Cuts
The Federal Reserve recently made its first interest rate cut in more than four years, reducing their benchmark rate by 0.50% at their September 18 meeting. Although this move was widely anticipated, we want to unpack what this means for your investments and where we expect interest rates to go from here.
What This Means
Despite common impressions, the Fed has limited control over interest rates. When we hear that the Fed “cut interest rates,” what they have really done is reduced the overnight-lending rate between banks. Although interest rates across the economy often decrease as well, they don’t have to move in lockstep. Markets tend to anticipate these changes, and this last announcement was no exception: bond yields (the returns investors receive when they purchase new bonds) dropped from 4.5% at the start of July to 3.7% on the day the Fed made their announcement¹.
Here’s the good news: falling interest rates lead to higher prices, boosting the returns of the bonds in your portfolio. While we don’t expect this tailwind to continue indefinitely, your portfolio has benefited from declining rates.
Like bond yields, mortgage rates also fell in advance of the announcement, declining from a peak of 7.8% in October 2023 to 6.1% in September². Other interest rates, like those on credit cards, often take longer to adjust. Credit card companies may be slow to lower rates, especially if they suspect borrowers will have trouble paying their bills, so expect a few billing cycles before consumers will see any benefit to their credit card statement. Meanwhile, money market yields have started to decline and will likely fall by the full 0.50% cut made by the Fed.
What’s Next?
The Fed is constantly trying to balance two goals: they want the economy to operate at full employment while creating an environment of stable prices (typically, low, predictable inflation).
By cutting rates, the Fed has signaled that they are now just as concerned about a weakening labor market as they are about continued inflation. This is a positive shift, as the Fed expects price growth to continue to slow. While we don’t anticipate prices falling (which is called disinflation, a decline in prices that can hurt economic growth), we can expect smaller, more manageable price increases moving forward. This was confirmed by the latest inflation report which suggested that headline inflation continues to remain low. We welcome this news as more predictable prices are good for both businesses and consumers.
The Fed has two more meetings this year, and they’ll continue to watch data from both inflation and the labor market as they evaluate the future path of rates. Markets currently expect two more rate cuts, with the benchmark rate moving down to 4.25-4.50%³ by year-end. This is the baseline, so what will drive stock and bond returns from here will be how the rate changes unfold compared to the current expectations.
Bottom Line
The Fed’s recent rate cut is part of the natural economic cycle and is a completely natural and a healthy part of continued economic growth.
Our investment approach remains unchanged, and we continue to see fixed income as a reliable source of stability in your portfolio. Although we expect future bond purchases to have lower returns, we rely on bonds for stability, not as a primary source of returns. Even with falling rates, we remain focused on the things in our control, such as rebalancing your portfolio and managing your money in line with your personal values and goals.
As always, we’re here and ready to answer any questions you may have regarding how these market changes may have impacted your financial plan.
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1. Based on the 10-Year Treasury yield. Source: FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DGS10, October 3, 2024.
2. Based on the 30-Year Fixed Rate Mortgage Average in the United State. Source: Fannie Mae, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, October 3, 2024.
3. As of October 13, 2024. https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html.
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