The Fed delivers! What happens now?
“If past history was all that is needed to play the game of money, the richest people would be librarians.”
As the market widely anticipated, the Federal Reserve cut interest rates by 0.25% today (July 31, 2019). The stock market’s growth of about 20% year-to-date prior to the announcement is due in part to this expected good news from the Fed, which now has been confirmed.
As Warren Buffett’s quote above states – history doesn’t dictate the future. A cut in interest rates in the past may have provided a source of stimulus to spur economic growth along with increased borrowings and “cheap money”. However, this time around interest rates are starting from an already low level. In addition, this rate cut was already largely priced into the market.
Why is this announcement so important? The July meeting of the Federal Open Market Committee marked a pivotal point where growth rates from abroad have weakened, inflation remains below target, and continuing trade concerns have all increased downside risks. In order to support the market gains year-to-date, additional stimulus was perceived as necessary. If not delivered, it could have presented significant downward pressure on stock prices. But will lower rates provide any meaningful lift in growth or have any significant impact to your portfolio?
As a reminder, the Fed controls short-term interest rates, specifically the Federal funds rate which is what banks pay other banks for overnight funds. The Fed funds rate has decreased from a target range of 2.25% to 2.50% to a target range of 2.00% to 2.25%. Other rates that typically move in line with the Fed funds rate include banks’ Prime rate (what banks charge their best customers), most adjustable-rate and interest-only loans, and credit card rates. Also, the cash rate paid on money market accounts and 3-month CDs tend to move with the Fed funds rate.
Most managed portfolios are invested in short term and intermediate bonds where a change in the Fed funds rate would not have any immediate impact on market values or yields. The yield curve has already anticipated lower rates as the bond markets have pushed 10-year Treasury bond rates down to 2.08% this week ahead of the announcement, hence the inverted yield curve discussed in more length in our second quarter Your Family CFO Report.
In summary, the Fed rate cut today is important, as the market determined it was necessary to support growth and the markets would have likely experienced significant volatility without a rate cut. Typically, once the Fed has made a move then it will continue additional moves in that direction and today signals the beginning of additional decreases in rates. Rate cuts from the existing low levels may not provide the traditional boost to economic growth as rate cuts in the past have historically provided. In addition, a change in short term rates will not have a meaningful impact on bond portfolios invested in longer term maturities. The main beneficiaries of lower rates will be borrowers with adjustable rate loans and stock owners wanting to hold on to existing gains.
As always please contact us with any questions or comments. We look forward to talking with you soon. Thank you for your continued confidence in Smith & Howard Wealth Management.
Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.