What does the Federal Reserve’s policy rate cut mean for our portfolios? Will interest rates keep falling? What changes should we make?
Topics covered include:
- What determines interest rates, and where are those drivers currently
- What is the best estimate of bond returns
- How duration works and why it changes
- What are some current fixed income investment options
Show Notes
Summary of Economic Projections—US Federal Reserve
Investors may be getting the Federal Reserve wrong, again—The Economist
Term Premium on a 10 Year Zero Coupon Bond—Federal Reserve Bank of St. Louis
The Truth about Yield by Jason Bove and Mark Willauer—J.P. Morgan
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Transcript
Coming Soon
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 495. It’s titled, “The Federal Reserve Cut Rates. What Happens Now?”
Federal Reserve Policy Rate Cut
Last week the Federal Reserve Open Market Committee reduced its policy rate by a half a percentage point. The new range is 4.75% to 5%. Now, it was all but certain that they would lower its policy rate, but what was a toss-up was whether the cut would be a bold half a percent, or a more modest quarter of a percent.
The challenge with a half-percentage point reduction is it could signal that the Federal Reserve felt it was behind in reducing its policy rate; that the economy was slowing more significantly than what the Fed was comfortable with.
I shared in our Insider’s Guide newsletter last week, the day of the cut, that in the past 25 years when the Federal Reserve began reducing its policy rate as part of a monetary easing cycle, when it reduced it by a half a percent, the U.S. economy always entered into a recession.
Now, there were three times: 2001, 2007, and 2020. Conversely though, when the Federal Reserve started off and continued with quarter percentage points cuts each and every time, the three times that occurred—1995, 1998, and 2019—the U.S. avoided a recession. The one exception was 1990. The Federal Reserve started with a quarter percentage point cut and then followed with three half a percentage points cuts when the U.S. economy entered into a recession.
The Fed started with a half a percent. Powell said “As inflation has declined and the labor market has cooled, the upside risks to inflation have diminished, and the downside risks to employment have increased. We now see the risk to achieving our employment and inflation goals as roughly in balance, and we are attentive to the risk to both sides of our dual mandate.”
The Federal Reserve has a dual mandate: full employment while keeping inflation under control.
Later in his press conference, Powell said “I don’t see anything in the economy right now that suggests the likelihood of a downturn is elevated.” In fact, in their statement, the first line of the Federal Open Market Committee’s statement released a week ago says “Recent indicators suggest that economic activity has continued to expand at a solid pace.”
Economic Soft Landing
The Federal Reserve expects an economic soft landing. Their updated economic forecasts that were also released last week confirms this soft landing expectation, that the U.S. will not enter into a recession. That there’ll be a gradual slowdown of the economy, but it will avoid contraction in GDP.
Powell in his press conference said “We are not on any preset course. We will continue to make our decisions meeting by meeting.” Why? Because the Federal Reserve Open Market Committee, the participants, and Federal Reserve Chair Powell, they don’t know what’s going to happen. They don’t know whether inflation will continue to come down. They expect it to. They don’t know if the economy will hold or enter into recession. They don’t expect it to. They expect the economy to continue to expand at a solid pace.
So where will interest rates go from here? The most probable scenario is interest rates will continue to decline as the Federal Reserve reduces its policy rate.
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