As a follow up to my recent video on this subject, I thought it would make sense to dive a little deeper into the recent Fed rate cuts, and what happens now. The Federal Reserve’s interest rate decisions remain a focal point for markets. While the timing and size of rate cuts are the subject of debate, why the central bank is cutting rates and how the full rate cut cycle might play out are far more important.
This is because the implications are not as straightforward as they might seem, and market expectations have shifted dramatically over the past year. What should we know about how rate cuts have historically impacted the economy and markets?
The rationale behind Fed rate cuts is important
The Fed typically lowers interest rates in response to a weakening economy, since doing so makes it cheaper for individuals and companies to borrow, while also increasing the incentive to spend rather than save. In theory, this boosts growth and supports the financial system, especially during recessions and financial crises. Over the past few decades, the Fed made dramatic rate cuts during the early 2000s dotcom bust, the 2008 global financial crisis, and the pandemic in 2020.
How the economy and markets typically behave during rate cut cycles can be easily misunderstood from these historical episodes. While lowering rates is intended to promote growth, doing so during an economic crash means that a recession and bear market are likely to follow and last several quarters after the first cut. This means that rate cuts are historically correlated with poor market returns even though it’s clear that rate cuts were in response to, rather than the cause of, these challenges.
Conversely, while rate hikes are typically seen as slowing the economy, they often occur during economic booms and bull markets as the Fed slowly pumps the brakes. Thus, counterintuitively, rate hikes have historically corresponded to strong returns.
Today, the Fed is not battling a sudden economic collapse or financial crisis, but is instead navigating a period of steady but slowing growth with improving inflation and a weakening but still strong labor market. In other words, the current situation is quite different from periods of emergency rate cuts. This is why the rationale for lowering rates matters when considering how they might impact markets in the months and years ahead.
Perhaps a more applicable example is the 1994-1996 rate cycle, when the Fed raised rates to combat inflation fears before lowering them again shortly thereafter. Periods like these are often referred to as “soft landings” since the Fed arguably managed to cool the economy without triggering a recession. While there was a significant shock to the bond market – just as there was in 2022 – markets eventually responded positively to rate cuts once the economy stabilized.
The Fed’s task is to balance inflation and growth
The Fed’s dual mandate, as described in the 1977 Federal Reserve Act, is “to promote maximum employment and stable prices.” Today, this is interpreted as returning inflation to 2% while ensuring the economy continues to grow steadily.
These objectives can be in conflict, since faster growth should, in theory, result in higher inflation. From 2009 to early 2020, inflation was nearly non-existent, allowing the Fed to keep interest rates exceptionally low resulting in one of the strongest job markets in history. In contrast, the inflation of the past few years has required the Fed to make tough choices between price stability and jobs.
Fortunately, inflation has been improving since its peak in 2022. The latest Consumer Price Index report showed that prices continued their gradual descent in August, with the headline index rising only 2.5% year-over-year. However, the Fed is hesitant to declare victory since core CPI, which excludes volatile food and energy prices to measure the underlying trend, experienced a slight uptick to 3.2%. This was primarily due to stickiness in housing prices which has been a point of concern for economists.
It’s been said that monetary policy works with “long and variable lags.” In other words, if the Fed waits for inflation to be all the way back down to 2%, it may have waited too long. The cost of doing so would be an over-tightening of the job market, which would have real world consequences on households and businesses. Thus, the recent softening in the employment data provides further support for reducing rates.
Bond yields are adjusting to rate cuts
While the past is no guarantee of the future, lower rates have been positive for both stocks and bonds across history. Bond prices, in particular, move in the opposite direction of bond yields, which is why many bond indices have rebounded in recent weeks.
Given these economic trends, most economists and investors believe the Fed will cut rates a few times this year and throughout 2025. Bond yields have responded with the yield curve “disinverting” for the first time since the rate hike cycle began in 2022. This is because short-term interest rates, which are tied to Fed policy, have begun to fall while long-term interest rates, which are tied to economic growth, have not declined as much. This results in an “upward-sloping” yield curve which is often seen as positive for the economy.
While the past is no guarantee of the future, lower rates have been positive for both stocks and bonds across history. Bond prices, in particular, move in the opposite direction of bond yields, which is why many bond indices have rebounded in recent weeks.
For stocks, lower interest rates mean that businesses have access to cheaper financing for investment and expansion. When it comes to the math of valuing companies, lower rates mean that future cash flows are discounted less, which can result in more attractive prices today. Of course, the market never moves up in a straight line, and we should always be prepared for periods of volatility as the financial system adjusts to Fed moves.
As we enter a new phase of monetary policy, economists will be closely monitoring these indicators, particularly those related to employment and growth. The Fed’s challenge will be to calibrate its policy response to support the economy without reigniting inflationary pressures or creating imbalances in financial markets.
The bottom line? Understanding why the Fed is cutting rates is as important as the policy moves themselves. Rather than focus on individual rate cuts, try to maintain a long-term perspective to stay on track towards your financial goals.
Source: Clearnomics
Concerns or questions about how your investment portfolio will hold up in the current market environment? Contact Financial Synergies today.
We are a boutique, financial advisory and total wealth management firm with over 35 years helping clients navigate turbulent markets. To learn more about our approach to investment management please reach out to us. One of our seasoned advisors would be happy to help you build a custom financial plan to help ensure you accomplish your financial goals and objectives. Schedule a conversation with us today.
More relevant articles by Financial Synergies:
Blog Disclosures
This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own financial advisors as to legal, business, tax, and other related matters concerning any investment.
The commentary in this “post” (including any related blogs, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Financial Synergies Wealth Advisors, Inc. employees providing such comments, and should not be regarded as the views of Financial Synergies Wealth Advisors, Inc. or its respective affiliates or as a description of advisory services provided by Financial Synergies Wealth Advisors, Inc. or performance returns of any Financial Synergies Wealth Advisors, Inc. client.
Any opinions expressed herein do not constitute or imply endorsement, sponsorship, or recommendation by Financial Synergies Wealth Advisors, Inc. or its employees. The views reflected in the commentary are subject to change at any time without notice.
Nothing on this website constitutes investment or financial planning advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. It also should not be construed as an offer soliciting the purchase or sale of any security mentioned. Nor should it be construed as an offer to provide investment advisory services by Financial Synergies Wealth Advisors, Inc.
Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Synergies Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Any charts provided here or on any related Financial Synergies Wealth Advisors, Inc. personnel content outlets are for informational purposes only, and should also not be relied upon when making any investment decision. Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always please remember investing involves risk and possible loss of principal capital; please seek advice from a licensed professional. Any projections, estimates, forecasts, targets, prospects and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Information in charts have been obtained from third-party sources and data, and may include those from portfolio securities of funds managed by Financial Synergies Wealth Advisors, Inc. While taken from sources believed to be reliable, Financial Synergies Wealth Advisors, Inc. has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. All content speaks only as of the date indicated.
Financial Synergies Wealth Advisors, Inc. is a registered investment adviser. Advisory services are only offered to clients or prospective clients where Financial Synergies Wealth Advisors, Inc. and its representatives are properly licensed or exempt from licensure. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
See Full Disclosures Page Here
Fed Rate Cuts: What Happens Now?
As a follow up to my recent video on this subject, I thought it would make sense to dive a little deeper into the recent Fed rate cuts, and what happens now. The Federal Reserve’s interest rate decisions remain a focal point for markets. While the timing and size of rate cuts are the subject of debate, why the central bank is cutting rates and how the full rate cut cycle might play out are far more important.
This is because the implications are not as straightforward as they might seem, and market expectations have shifted dramatically over the past year. What should we know about how rate cuts have historically impacted the economy and markets?
The rationale behind Fed rate cuts is important
The Fed typically lowers interest rates in response to a weakening economy, since doing so makes it cheaper for individuals and companies to borrow, while also increasing the incentive to spend rather than save. In theory, this boosts growth and supports the financial system, especially during recessions and financial crises. Over the past few decades, the Fed made dramatic rate cuts during the early 2000s dotcom bust, the 2008 global financial crisis, and the pandemic in 2020.
How the economy and markets typically behave during rate cut cycles can be easily misunderstood from these historical episodes. While lowering rates is intended to promote growth, doing so during an economic crash means that a recession and bear market are likely to follow and last several quarters after the first cut. This means that rate cuts are historically correlated with poor market returns even though it’s clear that rate cuts were in response to, rather than the cause of, these challenges.
Conversely, while rate hikes are typically seen as slowing the economy, they often occur during economic booms and bull markets as the Fed slowly pumps the brakes. Thus, counterintuitively, rate hikes have historically corresponded to strong returns.
Today, the Fed is not battling a sudden economic collapse or financial crisis, but is instead navigating a period of steady but slowing growth with improving inflation and a weakening but still strong labor market. In other words, the current situation is quite different from periods of emergency rate cuts. This is why the rationale for lowering rates matters when considering how they might impact markets in the months and years ahead.
Perhaps a more applicable example is the 1994-1996 rate cycle, when the Fed raised rates to combat inflation fears before lowering them again shortly thereafter. Periods like these are often referred to as “soft landings” since the Fed arguably managed to cool the economy without triggering a recession. While there was a significant shock to the bond market – just as there was in 2022 – markets eventually responded positively to rate cuts once the economy stabilized.
The Fed’s task is to balance inflation and growth
The Fed’s dual mandate, as described in the 1977 Federal Reserve Act, is “to promote maximum employment and stable prices.” Today, this is interpreted as returning inflation to 2% while ensuring the economy continues to grow steadily.
These objectives can be in conflict, since faster growth should, in theory, result in higher inflation. From 2009 to early 2020, inflation was nearly non-existent, allowing the Fed to keep interest rates exceptionally low resulting in one of the strongest job markets in history. In contrast, the inflation of the past few years has required the Fed to make tough choices between price stability and jobs.
Fortunately, inflation has been improving since its peak in 2022. The latest Consumer Price Index report showed that prices continued their gradual descent in August, with the headline index rising only 2.5% year-over-year. However, the Fed is hesitant to declare victory since core CPI, which excludes volatile food and energy prices to measure the underlying trend, experienced a slight uptick to 3.2%. This was primarily due to stickiness in housing prices which has been a point of concern for economists.
It’s been said that monetary policy works with “long and variable lags.” In other words, if the Fed waits for inflation to be all the way back down to 2%, it may have waited too long. The cost of doing so would be an over-tightening of the job market, which would have real world consequences on households and businesses. Thus, the recent softening in the employment data provides further support for reducing rates.
Bond yields are adjusting to rate cuts
Given these economic trends, most economists and investors believe the Fed will cut rates a few times this year and throughout 2025. Bond yields have responded with the yield curve “disinverting” for the first time since the rate hike cycle began in 2022. This is because short-term interest rates, which are tied to Fed policy, have begun to fall while long-term interest rates, which are tied to economic growth, have not declined as much. This results in an “upward-sloping” yield curve which is often seen as positive for the economy.
While the past is no guarantee of the future, lower rates have been positive for both stocks and bonds across history. Bond prices, in particular, move in the opposite direction of bond yields, which is why many bond indices have rebounded in recent weeks.
For stocks, lower interest rates mean that businesses have access to cheaper financing for investment and expansion. When it comes to the math of valuing companies, lower rates mean that future cash flows are discounted less, which can result in more attractive prices today. Of course, the market never moves up in a straight line, and we should always be prepared for periods of volatility as the financial system adjusts to Fed moves.
As we enter a new phase of monetary policy, economists will be closely monitoring these indicators, particularly those related to employment and growth. The Fed’s challenge will be to calibrate its policy response to support the economy without reigniting inflationary pressures or creating imbalances in financial markets.
The bottom line? Understanding why the Fed is cutting rates is as important as the policy moves themselves. Rather than focus on individual rate cuts, try to maintain a long-term perspective to stay on track towards your financial goals.
Source: Clearnomics
Concerns or questions about how your investment portfolio will hold up in the current market environment? Contact Financial Synergies today.
We are a boutique, financial advisory and total wealth management firm with over 35 years helping clients navigate turbulent markets. To learn more about our approach to investment management please reach out to us. One of our seasoned advisors would be happy to help you build a custom financial plan to help ensure you accomplish your financial goals and objectives. Schedule a conversation with us today.
More relevant articles by Financial Synergies:
Blog Disclosures
This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own financial advisors as to legal, business, tax, and other related matters concerning any investment.
The commentary in this “post” (including any related blogs, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Financial Synergies Wealth Advisors, Inc. employees providing such comments, and should not be regarded as the views of Financial Synergies Wealth Advisors, Inc. or its respective affiliates or as a description of advisory services provided by Financial Synergies Wealth Advisors, Inc. or performance returns of any Financial Synergies Wealth Advisors, Inc. client.
Any opinions expressed herein do not constitute or imply endorsement, sponsorship, or recommendation by Financial Synergies Wealth Advisors, Inc. or its employees. The views reflected in the commentary are subject to change at any time without notice.
Nothing on this website constitutes investment or financial planning advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. It also should not be construed as an offer soliciting the purchase or sale of any security mentioned. Nor should it be construed as an offer to provide investment advisory services by Financial Synergies Wealth Advisors, Inc.
Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Synergies Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Any charts provided here or on any related Financial Synergies Wealth Advisors, Inc. personnel content outlets are for informational purposes only, and should also not be relied upon when making any investment decision. Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always please remember investing involves risk and possible loss of principal capital; please seek advice from a licensed professional. Any projections, estimates, forecasts, targets, prospects and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Information in charts have been obtained from third-party sources and data, and may include those from portfolio securities of funds managed by Financial Synergies Wealth Advisors, Inc. While taken from sources believed to be reliable, Financial Synergies Wealth Advisors, Inc. has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. All content speaks only as of the date indicated.
Financial Synergies Wealth Advisors, Inc. is a registered investment adviser. Advisory services are only offered to clients or prospective clients where Financial Synergies Wealth Advisors, Inc. and its representatives are properly licensed or exempt from licensure. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
See Full Disclosures Page Here
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