Anticipating a bullish trend for stocks but a bearish outlook for bonds? Here’s what rate cuts could mean for your financial portfolio.
For the first time in over four years, the Federal Reserve is preparing to lower interest rates, potentially impacting various financial assets such as U.S. stocks, bonds, and savings accounts.
During the annual Jackson Hole Economic Symposium on Aug. 23, Fed Chair Jerome Powell indicated that it was time for policy adjustments, addressing a gathering of bankers, economists, and monetary policymakers.
As we approach the September policy meeting, financial markets will be speculating about the magnitude and frequency of rate cuts.
With this in mind, many individuals may be wondering about the potential impact of the Fed’s easing cycle on their finances.
Implications for Wall Street Bulls
Prior to Powell’s endorsement of a rate cut, major benchmark indexes saw positive performance, recovering from a recent three-day market downturn.
Year-to-date, the Dow Jones Industrial Average has increased by over 9 percent, the Nasdaq Composite Index has surged nearly 20 percent, and the S&P 500 has risen by about 18 percent.
Is there room for further growth, or has the anticipation of a Fed rate cut already been factored into the market?
Robert Johnson, Chairman and CEO of Economic Index Associates and finance professor at Heider College of Business, believes that the stock market is likely to benefit from the Fed’s monetary policy easing, leading to positive expectations for broad equity market returns.
According to Johnson, historical data from 1966 to 2023 shows that the S&P 500 yielded a 16.4 percent return when interest rates were lowered by the Fed. Conversely, the index generated a 6.2 percent return when the central bank raised rates.
Furthermore, in a low-rate environment, top-performing sectors have included automobiles, apparel, and retail, while underperforming sectors have been financials, consumer goods, and utilities.
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David Materazzi, CEO of automated trading platform Galileo FX, predicts that the stock market will experience a surge following the rate cut, potentially leading to a short-term increase in stock prices. However, Materazzi advises retail investors to be cautious and avoid getting carried away by the hype of continuous growth.
“This environment may create bubbles and result in overvalued assets,” he remarked. “It is essential to focus on stocks with strong fundamentals that can withstand market corrections once the initial excitement subsides. Don’t let the market’s enthusiasm blind you to the underlying risks.”
Impact on Safe-Haven Assets
The high-rate environment maintained by the Fed over the past two years has benefited bond investors and savers while posing financial challenges for borrowers.
Money markets, which encompass short-term debt securities and cash equivalents, have attracted significant investments from both institutional and individual investors due to yields of approximately 5 percent.
Since the Fed began its quantitative tightening in March 2022, money market funds have experienced heightened retail interest.
However, with the central bank now lowering its policy rate from the current 23-year high of 5.25 percent and 5.5 percent, experts suggest that bond investors may need to shift towards longer-term duration instruments.
“As investors anticipate lower future interest rates, they may increase their investments in the long end of the yield curve, such as corporate and treasury bonds with maturities of 15, 20, or 30 years, where interest rate movements have a greater impact on prices,” explained Michael Ashley Schulman, Partner and CIO of Running Point Capital Advisors.
The benchmark 10-year yield decreased following Powell’s speech, falling below 3.8 percent.
Additionally, the era of cash dominance in recent years may come to an end.
Although the Fed does not directly dictate interest rates on savings accounts, its benchmark federal funds rate influences rates across the financial market, including automobile loan rates, savings account rates, mortgage rates, and credit card rates.
“As the Fed lowers its target Fed funds rate, rates throughout the financial markets will decline,” noted Johnson.
Gold, a traditional safe-haven asset, is expected to benefit from the Fed’s looser monetary policy.
Alex Ebkarian, the COO and co-founder of precious metals dealer Allegiance Gold, emphasizes that the expectation of a rate cut by the Fed has been a driving force behind gold’s bull run this year. In a lower interest rate environment, gold becomes more attractive compared to bonds due to the decrease in the opportunity cost of holding non-yielding bullion. Ebkarian points out that bonds typically offer weaker returns in such scenarios, making gold a more appealing option.
While interest rates have been a focal point for market watchers, other factors such as economic conditions, government regulation, employment, trade and tax policies, and international conflicts can also influence investor sentiment and the broader financial markets. For example, during the August 2024 market meltdown, concerns were alleviated after positive initial jobless claims reports followed a weaker-than-expected Manufacturing Purchasing Managers’ Index (PMI) and July jobs report.
As the Fed prepares for its next policy meeting, the financial markets will be monitoring various economic indicators and events, from the August jobs report to geopolitical tensions and the 2024 presidential election. Movements on the New York Stock Exchange may be driven by more than just interest rate changes.
In a falling-rate climate, savers may be disappointed, but borrowers and investors will likely benefit in the next policy cycle. Ultimately, the interplay of various factors beyond interest rates will continue to shape market dynamics in the coming months.
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