On Sept. 18, 2024, the Federal Reserve Bank (the Fed) reduced the target federal funds rate by half a percentage point to a range of 4.75 to 5 percent, marking the first rate cut since the start of the pandemic in March of 2020. The move, which follows 11 consecutive rate hikes between March 2022 and July 2023, signals the Fed’s confidence that “inflation is moving sustainably toward 2 percent, and the risks to achieving its employment and inflation goals are roughly in balance.” With additional rate cuts expected over the next 12 months, investors find some opportunities to diversify their investment portfolios and lock-in higher interest rates.
Understanding the Federal Funds Rate
The federal funds target rate (Fed Funds rate) is the short-term interest rate the Fed sets for banks and credit unions to charge one another when borrowing or lending money overnight to meet their reserve requirements. Lenders also use it as a reference point for the rates they charge borrowers on loans, mortgages and credit card balances, and the savings rate banks extend to their customers.
The Fed can adjust the Fed Funds rate to help manage the U.S. money supply that likely leads to changes in key economic indicators, such as inflation and employment. For example, it can increase the Fed Funds rate to slow economic activity, tame inflation and make it more costly for consumers to borrow money. Essentially, this helps curb spending, which can, in turn, slow job growth. By contrast, the Fed may reduce the Fed rate to help stimulate the economy, increase consumer spending and support job growth. This is the case in the current cycle, which has been marked by decelerating inflation from a 40-year high of 9.1 percent in June 2022 to 2.5 percent in August 2024. However, according to the Fed and its rationale behind the recent rate cut, rising unemployment and slowing wage growth remain problematic in its efforts to avoid a prolonged economic downturn.
Bonds
There is an inverse relationship between interest rates and bond prices. As interest rates fall, prices on existing bonds rise. By contrast, existing bond prices fall and lose their current value during a rising interest rate environment. To measure how much bond prices are likely to change in response to interest rate movements, investors should look at the duration of each bond they hold. The longer the duration, the more sensitive bonds are to movements in interest rates.
Stocks
While there is a correlation between interest rate fluctuations and corporate profits, the impact on the public equities market is not as clear-cut as the relationship between the Fed Funds rate and bonds.
Generally, rising interest rates make borrowing more expensive and portend cutbacks in business and consumer spending. Moreover, as was the case in 2022, a rapidly rising interest rate environment negatively impacts stock prices, as companies’ future cash flows are discounted back to the stock price at a higher rate, making future cash flows less attractive. By contrast, lower interest rates tend to lead to higher prices. With the recent Fed Funds rate reduction, companies’ borrowing costs are expected to decline, allowing them to increase spending and earn more on their investments.
Making financial decisions in response to economic changes should be conducted under the guidance of professional financial advisors who can ensure that your short-term actions align with your longer-term needs and wealth preservation goals.
About the Author: Shane Phillips, CFA, CAIA, CFP®, is a senior portfolio manager and financial advisor with Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Fort Lauderdale, Fla., office at (954) 712-8888 or info@provwealth.com.
Provenance Wealth Advisors (PWA), 200 E. Las Olas Blvd., 19th Floor, Ft. Lauderdale, FL 33301 (954) 712-8888.
Shane Phillips, CFA, CAIA, CFP®, is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC.
This material is being provided for information purposes only and is not a complete description or recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult your financial advisor about your individual situation.
* Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
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Posted on October 4, 2024