All Focus on the Federal Reserve - Part 3
The Federal Reserve is expected to cut interest rates this afternoon, the first time since March 2020. In light of this, we wanted to share a three-part blog on the rationale for a cut, the Federal Reserve’s underlying goal, and how rates, bonds, and stocks may react.
Read Part One Here or Part Two Here if you missed it.
Bond yields are adjusting to rate cuts.
Given the 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 “dis-inverting” 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 investors 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, investors should maintain a long-term perspective to stay on track toward our financial goals.
Thanks for reading, and we hope you have a great rest of your week!
Shean