Interest Rates Are Finally Falling – Here’s Why, And What May Happen As A Result
Laurence Hale, AAMS®, CRPS®
Principal/Managing Partner, Investment Advisor & Chief Investment Officer
After rising for the better part of two years, interest rates have reversed course and have started falling. The move picked up steam after July’s Federal Reserve meeting, when Chairman Jay Powell indicated that inflation may be whipped and the Fed may soon start lowering interest rates. At a post-meeting press conference, he said: “A reduction in the policy rate could be on the table as soon as the next meeting in September.”
Powell, like many Fed officials, tends to couch his statements with qualifiers. But on this occasion, the Fed Chair’s comment was surprisingly blunt. It also implied that the Fed would cut rates even as the Presidential election campaign heat up. The Fed aims to be apolitical and typically avoids raising or cutting interest rates near an election, for fear of being perceived as favoring one candidate over another. However, this time around, a rate cut appears to be in the cards regardless of the November election.
Powell’s comments have already had an impact on stock and bond markets as they anticipate the actual event. Let’s take a look at what was behind the Fed’s change of heart and how markets are reacting.
Inflation & Jobs
The Federal Reserve has two main goals: Keep inflation low and keep the job market strong. While jobs have been plentiful in recent years, inflation has been anything but low. Much of the problem has its roots in the Covid pandemic. To support the economy during the pandemic, the Federal Reserve lowered interest rates to zero. With the same goal in mind, the federal government gave funding and tax breaks to individuals and businesses to help them survive the extraordinary time.
While these moves kept the economy growing, they also sent prices skyrocketing. Inflation, as measured by the Consumer Price Index, surged 9.1% in June 2023, a rate that hadn’t been seen since 1981 and was far above the Fed’s target of 2%.
The Fed responded by raising the federal funds rate. The Fed’s interest rate influences how much banks charge when they make loans. As the Fed’s interest rate rose, so too did interest rates on business loans, auto and credit card loans, and mortgages. As rates rise, people are less likely to buy a new car or home or take out a business loan.
This cycle was no exception. Demand for goods and services proceeded to slow and prices began to climb much more slowly. Second quarter gross domestic product, a broad measure of economic activity, grew a moderate 2.8%. Meanwhile, CPI rose 3.0% in June from a year earlier, and it actually fell 0.1% from the prior month.
If a rate cut occurs, it will be a major policy reversal. The Fed has been boosting interest rates for the last two years in an effort to fight inflation by slowing the economy’s growth. From March 2022 through July 2023, the Fed raised the Federal funds rate target eleven times from 0.0%-0.25% up to the latest target of 5.25%-5.50%.
Now economists and investors are concerned that the Federal Reserve may have raised interest rates too high and kept them at elevated levels for too long. Investors fear the economy is about to enter a recession. Companies added fewer jobs to their payrolls in July than was expected and the unemployment rate ticked up to 4.1%, up from 3.7% at the beginning of the year. Fortunately, inflation no longer appears to be problematic, so the Fed has the flexibility to cut interest rates to bolster the job market.
read more below
get started on living well
Subscribe to the Fearless Flyer
Get the financial tips and insights you need to fearlessly pursue your goals, plus access to subscriber-only benefits like our Tax Resource Center and more.
The Market Responds
Powell’s comments and the weaker than expected employment report had an immediate impact on the markets. The futures market expects the Fed to cut rates at least four times over the next six months in an effort to keep the economy out of a recession. The 10-year Treasury bond rose in value and its yield fell below 4% for the first time since January. The two-year Treasury price rose as well and its yield dropped to less than 4%, down from roughly 5% in April.
Lower interest rates will mean it’s less expensive for companies and municipalities to borrow money. It’s also great news for consumers who want to take out a car or home loan. The interest rate on a 30-year home loan has fallen from almost 8.0% late last year to roughly 6.75%.
Investors who bought bonds or bond funds when interest rates were higher should be sitting on investment gains. And while investors who kept their money in short term investments like money market funds or CDs may have lost an opportunity to buy a 10-year Treasury bond yielding almost 5%, they can still buy corporate bonds yielding more than 5% if they’re willing to accept more credit risk.
In the stock market, interest-rate sensitive stocks have rallied sharply. The S&P 500 Homebuilding stock price index has jumped roughly 20% in the past month. However, fears of a recession have driven most stock prices down from the record levels hit earlier this year. Much will depend on how successful the Fed will be in lowering interest rates enough to boost economic growth.
Our team of financial advisors at WHZ can help you determine how a rising interest rate environment will affect your investment portfolio. At WHZ, our strategic Plan Well. Invest Well. Live Well.™ financial planning process looks at your full financial life when constructing a portfolio that will help you achieve your goals. Contact us for a complimentary consultation or call us at (860) 928-2341 if you're seeking a knowledgeable partner to help craft a hyper-personalized financial plan to provide Absolute Confidence. Unwavering Partnership. For Life.
Authored by Principal/Managing Partner Laurence Hale AAMS, CRPS®. Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084. 860-928-2341. www.whzwealth.com.
You & Your Money Podcast
Tune in for market updates and financial tips to help you Plan Well, Invest Well and Live Well.
WHZ on YouTube
Quick Tip videos designed to empower you to reach your financial life goals.