Initiation of FOMC Rate Cut Cycle: Long Time Coming

As many of you may be aware, the FOMC concluded their September meeting by cutting the Fed Funds Rate by fifty bringing the effective rate down from 5.375% to 4.875%. While there were initial thoughts that the move would be for 25 bps, the FOMC determined that based on the data, a fifty bp reduction was appropriate at this time. The Federal Open Market Committee (FOMC) has two primary mandates:

1. Maximum Employment: The FOMC seeks to promote maximum employment levels in the United States. In other words, they strive for a low unemployment rate and a strong labor market.
2. Price Stability: The FOMC also aims to achieve price stability, which is typically defined as an inflation rate of around 2% per year. This means maintaining a stable purchasing power for the U.S. dollar.

According to the comments in the press release at the time of the announcement, “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.” – (Federal Reserve Press Release). They did also note that they will continually monitor the implications of the recent actions and “adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”

Let us break this down into how the actions of the FOMC could possibly impact the overall economy and marketplace.  We will begin by discussing some of the potential negative impacts but end on the positive side which we believe is the more impactful of the two sides of the coin:

Potential Negative Impacts:

• Inflationary Pressure: Lower interest rates can put upward pressure on inflation, especially if economic growth accelerates rapidly. This is where the line earlier is important as the FOMC noted that they will monitor the situation closely and take appropriate actions is they see inflation begin to creep higher.
• Increased Asset Prices: Lower interest rates can drive up asset prices, such as stocks and real estate, potentially creating asset bubbles. We continue to see stock prices react to potential valuation changes based on the discount rate which is impacted by the underlying Fed Funds Rate. This could lead to higher valuations as the discount factor is reduced due to lower overall rates. As for housing, we do continue to see home prices that are making it tougher for buyers to compete. That said, lower mortgage rates may make it slightly easier for individuals to make the move to purchase a house. We do, however, note that there must be responsible lending to home buyers to ensure we do not have another 2008-2009.
• Reduced Savings Returns: Lower interest rates can reduce the returns on savings accounts and other fixed-income investments. This is something that we have noted previously and is one of the reasons that we have taken strategic actions w/in multiple strategies to extend durations to try and achieve higher rates for longer periods of time.

Let us now discuss the potential positive side of the coin which we believe will have the greater impact on the economy:

Potential Positive Impacts:

• Stimulated Economic Growth: Lower interest rates can encourage borrowing, investment, and spending, boosting economic activity. As we have stated in the past, businesses may have placed a hold on capital expenditures due to the higher rate environment, but we may begin to see further investment (e.g., property, plant, equipment, etc.) as borrowing rates begin to lower due to this (and possible future) rate cuts
• Lower Mortgage Rates: This can make homeownership more affordable, stimulating the housing market. We are seeing mortgage rates continue to decline, but we also note that home prices continue to remain at elevated levels, so there may be a bit of a lag for this to really kick in. That said, we have started seeing positive movement in the housing starts and sales data over the past few months which should be viewed as a positive
• Increased Consumer Spending: Lower interest rates can reduce the cost of borrowing for consumers, leading to increased spending. We continue to see strength in Retail Sales data, but this action may lead to additional ease on consumers which could lead to further spending.
• Support for Financial Markets: A rate cut can help stabilize financial markets and reduce the risk of a credit crunch. This is one of the reasons that you typically see financial institutions benefit in declining rate environments. The reduction in rates associated w/ the liability section of their balance sheet (e.g., deposits, CDs, etc.) likely translate into increased Net Interest Margins (NIM) which is calculated as the difference in the interest income and the interest expense divided by the average earning assets.  While you do not really need to understand the math, the important takeaway is that an increasing NIM is considered a positive in the financial industry.

We are only hitting on a few of the potential implications of an FOMC rate cut cycle, but we will monitor the situation as it continues to unfold and provide additional insights and analysis as we move forward. This should be viewed as a positive action because it signals that the FOMC believes that the economy is still moving in a positive direction and that inflationary signals are continuing to show signs of improvement. Our goal here is to provide you w/ some initial thoughts of how the rate cut cycle may impact the overall economy and to ensure you that, above all, we are working behind the scenes to continually provide you w/ not only a financial education but, more importantly, Financial Peace of Mind.

As always, if you have any questions, please reach out to your trusted advisor. We hope that you are having a great start to the fall season!