Timely and Relevant News: Practical Insights From The Fed Rate Cut
As shared in our September communication, The Fed Lowers Interest Rates, the recent 50 basis point (bsp) cut was the first rate cut in four years. Many economist are expecting another rate cut of 25 bsp in December this year.
Whenever the Fed modifies the federal funds rate—up or down—it impacts the consumer. Some financial products may become more attractive, while others have a reverse effect. We've outlined some practical applications and potential market implications related to the recent move and any potential future rate cuts.
Impact on Borrowing Costs
One of the most immediate benefits of this rate cut is a reduction in borrowing costs. Here’s how:
Mortgages: A rate cut generally leads to lower interest rates on various types of mortgages, particularly adjustable-rate mortgages (ARMs) and new fixed-rate mortgages. When the Fed cuts rates, it reduces the cost of borrowing for banks, which often pass savings to consumers through lower mortgage rates. The Mortgage Bankers Association currently predicts the average 30-year rate to drop to 6.5% in 2024 and further to 5.9% in 2025. While Fannie Mae is forecasting 6.2% for 2024 and 5.7% for 2025.
Home Equity Lines of Credit (HELOCs): For those planning home improvements or consolidating debt, home equity lines of credit may become more affordable. Lower interest rates mean you’ll pay less in interest, potentially making it easier to manage monthly payments. HELOCs are tied to the prime rate and tend to follow the Fed's rate. Most HELOCs are variable with a monthly adjusted rate. Therefore, you could expect to see savings on your payments in the near-term if you have a variable rate HELOC.
Credit Cards: Interest rates for credit cards have been hovering at historically high levels, often above 21%. While the rate cut won’t lead to immediate changes, it may gradually lower interest rates on variable-rate credit cards since credit cards are tied to the prime rate.
Auto Loans and Personal Loans: If you're in the market for a new car or need a personal loan, the rate cut could make these types of credit more accessible.
Savings & CD Rates
While lower rates can be beneficial for borrowers, they can pose challenges for savers.
Savings Accounts and CDs: As interest rates drop, returns on savings accounts and Certificates of Deposit (CDs) may also decline because banks don't need to incentive deposits as much. It is cheaper to borrow money. We don't expect to see dramatic changes as banks tend to be slower to lower their deposit rates.
Investments & The Markets
Lower rates can impact the performance of various investments. For example, bond prices typically rise as interest rates fall, which could boost the value of fixed-income investments.
Year-to-date, the Russell 2000 (small company stocks) has returned 10.1%, while during that same period the large cap focused Russell 1000 has returned 20.8%. The anticipation of Fed rate cuts has given small caps a boost recently. The Russell 2000 has outperformed over the past three months (+9.9% vs. +5.5%).
Lower rates are a tailwind for small cap equities that tend to carry more debt. That said, these companies also tend to be more sensitive to economic activity, particularly within the U.S. as their revenues are less buffered by international sales. Stocks tend to move higher during rate cutting cycles without recessions, while stocks usually fall when rate cuts are accompanied by recessions. Our base case is no recession, however an economic slowdown could still limit potential small cap outperformance.
A Change In Fed Policy
The recent rate cut signals a shift in the Fed’s approach as it aims to stimulate economic growth, while also managing inflation. Many economist agree that we could see four to five rate cuts at a quarter-point each over the next 12 months.
Inflation has steadily declined in the past five months, falling from 3.5% in March to 2.5% in August. “Inflation is now much closer to our objective, and we have gained greater confidence that inflation is moving sustainably toward 2%,” said Federal Reserve Chair, Jerome Powell. The Fed also factored in employment data when they made their recent decision to cut rates. Fewer jobs were added in August than the previous 12-month average.
If you have specific questions or would like to discuss your own investment strategy or financial planning needs, we welcome you to call us at 302.234.5655 or email us at contactus@covenantwealthstrategies.com to set up time to discuss further.
Disclosures:
All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This Research material was prepared by LPL Financial, LLC, FactSet.