The SEIA Report Q3 2024

By Gene Balas, CFA®
Investment Strategist

Fed Rate Cuts: Implications for Your Portfolio

After an unprecedented rate-hiking cycle aimed at controlling the inflationary effects of Covid-era stimulus, the Federal Reserve (Fed) appears largely on track in its goal of combating inflation. Now, the Fed seems to have entered a new phase of rate cutting in hopes of achieving a soft economic landing. Most recently, the Fed announced its latest rate cut and signaled plans for only two more cuts in 2025, reinforcing its commitment to a cautious approach. One might ask, however, why is the Fed even cutting rates in the first place—and what does that mean for your portfolio?

Why Is the Fed Cutting Rates?

To understand the Fed’s decision to cut rates, it’s essential to recognize the Fed’s dual mandate: supporting maximum employment while maintaining price stability. It does so primarily by adjusting the short-term interest rates it controls, which help determine the interest rate on many loans, such as credit cards, some car loans, and businesses’ shorter-term borrowing, among other rates.

However, note that the rates on longer-term loans—such as mortgages—and yields on corporate and municipal bonds, are based on Treasury bond yields, which are largely market-driven, though may be influenced by Fed policy.

The Fed raises rates to make borrowing more expensive, thus reducing the demand for goods and services to combat inflation. Conversely, rate cuts are intended to stimulate the economy by lowering borrowing costs, encouraging spending, and boosting employment. With inflation moderating and concerns rising about potential economic slowing, the Fed has shifted its focus from reducing inflation to supporting employment.

Currently, the Fed funds rate remains above the “neutral” rate, a level that neither stimulates the economy nor slows it, placing current monetary policy in a restrictive zone. By cutting interest rates, the Fed is now moving closer to reaching this neutral interest rate. As such, investors should regard the Fed’s move as a return to a more normal interest rate environment, where the Fed is neither trying to combat inflation nor stimulate growth. The Fed’s goal is to reach a “soft landing”, where economic growth slows enough to reduce inflation but not so much that unemployment increases by an undesired amount.

What Do Rate Cuts Mean for Your Portfolio?

Next, as to the question of what the Fed rate cuts mean for your portfolio, there are some key themes.

1. Bonds: When interest rates fall, existing bonds become more valuable, and their prices typically rise. Why? Because they were issued at higher rates, making them more attractive than new bonds issued at lower rates. However, new bonds will offer lower yields, which means less income for investors. Of course, not all bonds react the same way—corporate or municipal bonds as well as mortgage-backed securities, which carry credit risk, may not necessarily rise or fall in tandem with Treasury bonds, which do not have credit risk.
2. Stocks: Historically, stocks have often performed well following Fed rate cuts, particularly if the economy avoids a recession, though past performance does not guarantee future results. Lower interest rates can stimulate economic growth by making borrowing cheaper for businesses, potentially boosting their profits. Plus, lower interest rates can lead to higher stock prices by making the future earnings or dividends of a company more valuable in current dollars. Sectors that tend to pay high dividends, like real estate and utilities, may become more attractive to income-seeking investors as yields on savings accounts and bonds decline, as can certain financial stocks like banks.
3. Savings Accounts and CDs: For savers, rate cuts typically mean a decrease in the interest earned on savings accounts and certificates of deposit (CDs). This can be disappointing for those relying on interest income, as their cash savings won’t grow as quickly.
4. Real Estate: Rate cuts may favor investments in commercial real estate or real estate investment trusts (REITs), especially those that pay high dividends. As borrowing becomes cheaper, these investments may become more attractive for income-seeking investors.

Conclusion

While the Fed’s rate cut is generally positive for investors, it’s important to remember that economic conditions  can change rapidly, and many factors influence the price of investments beyond Fed policy. The key is to stay informed, maintain a diversified portfolio aligned with your long-term goals, and avoid making drastic changes based on short-term market movements.

At SEIA, we’re here to help guide you through these changes and help ensure that your portfolio is properly positioned for not only Fed rate cuts but also the many other economic variables that shift constantly over time. We offer many different types of investment solutions, all of which are tailored to your investment goals and risk tolerance. As always, consult with your advisor for personalized guidance based on your unique circumstances and goals.

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Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications, and other factors. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses. SEIA is not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas. For details on the professional designations displayed herein, including descriptions, minimum requirements, and ongoing education requirements, please visit seia.com/disclosures. Signature Estate & Investment Advisors, LLC (SEIA) is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Securities offered through Signature Estate Securities, LLC member FINRA/SIPC. Investment advisory services offered through SEIA, 2121 Avenue of the Stars, Suite 1600, Los Angeles, CA 90067, (310) 712-2323.

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