Barrister Brief – Is the Fed Rate Cut Good or Bad?

The Impact of Fed Rate Cuts: What It Means for the Economy, Markets, and Personal Finances

Today, I want to discuss the anticipated Federal Reserve (Fed) rate cuts and what they might mean for the broader economy, financial markets, and our personal finances. The Fed is expected to cut interest rates by 25 basis points on September 18th. While there’s some speculation that the cut could be as large as 50 basis points, it’s more likely that they will start with a modest 25 basis point reduction. Let’s explore the potential implications of these changes.

Economic Implications: Are We Facing a Recession?

The direction of the economy will largely depend on whether the Fed is cutting rates into a slowing or more stable economy. Current data, including rising unemployment figures and slowing GDP growth, suggest that the economy is weakening. This signals that the Fed is likely cutting into a slowing economy, a factor that could push us closer to a recession.

To better understand the situation, consider three scenarios that typically explain why the Fed cuts rates:

1. Soft Landing: The economy remains stable, and GDP sustains at current levels.
2. Hard Landing: The economy falls into recession due to deteriorating conditions.
3. Liquidity Event: A significant market disruption, such as the 1987 stock market crash or the fall of Long-Term Capital Management, forces the Fed to cut rates to maintain financial stability.

Currently, many signs point to an economic slowdown, meaning we are more likely headed toward a hard landing, possibly even a recession. Indicators like a persistently low manufacturing index and an inverted yield curve (a classic sign of recession) raise concerns about where the economy is headed.

Market Outlook: What Could Happen to Stocks?

In the short term, the stock market’s reaction to Fed rate cuts has historically been negative, particularly over the three-to-six-month period following the initial cut. For example, in the 1970s and during the dot-com bubble and Great Financial Crisis (GFC), stocks experienced steep declines following rate cuts.

The risk today is compounded by high market valuations, a vast amount of consumer and government debt, and rising inflation. In my opinion, these factors indicate we are due for some type of downturn, and it’s likely we will see market weakness in the near term. For investors, this means taking a more defensive stance might be prudent, focusing on preserving capital rather than aggressively seeking growth.

Longer-term, however, market recoveries often follow these downturns. Looking back at events like the GFC, while the short-term outlook may have been bleak, those who stayed invested over the long term eventually saw positive returns. But it’s important to note that after major downturns, it can take several years for markets to recover to previous highs.

Personal Finances: What Does a Fed Rate Cut Mean for You?

If you’re wondering how this Fed rate cut will impact your personal finances, there are a few key takeaways to consider:

1. Savings Accounts and Money Markets: Expect yields on high-yield savings accounts and money market funds to decline. This is one of the more immediate effects of a Fed rate cut, and you’ll likely see these changes reflected in your account statements relatively soon.
2. Credit Cards and Loans: Interest rates on credit cards and personal loans may decrease slightly, making borrowing a little cheaper. However, these reductions will likely take longer to filter through the system than the drop in savings yields.
3. Car Loans and Mortgages: While new car loans and mortgages may see modest declines in interest rates, the impact may not be as significant as you’d hope. The housing market remains particularly challenging, with affordability at historic lows, and while mortgage rates may ease slightly, don’t expect a drastic improvement in conditions anytime soon.

A Defensive Approach to Investing

Given the economic uncertainty and the potential for a recession, we’ve maintained a defensive investment strategy for our portfolios. Protecting capital in times like these is often more important than focusing on growth, as large drawdowns can be difficult to recover from. To illustrate this, consider this scenario: If your portfolio experiences a 50% loss, you will need a 100% gain just to break even. This is why it’s essential to mitigate risks during periods of heightened market volatility, such as we’re experiencing now. The data suggests that while the Fed’s upcoming rate cut could provide short-term relief, the broader economic outlook remains uncertain. As we prepare for the September 18th rate cut, it’s wise to keep a defensive position, stay informed, and be prepared for what may come next.