Fed Cuts & Portfolio Implications
The Fed recently cut policy rates by a quarter of a percentage point (or 0.25%) continuing the easing cycle that began in 2024. This decision comes at a time when markets are near all-time highs, economic signals are mixed, and uncertainty around tariffs and inflation remain.
When it comes to monetary policy, why the Fed cuts rates often matters more than exactly when or by how much they cut. The following chart shows the Fed funds rate and illustrates how the current economic environment differs from previous cutting cycles:
The emergency cuts during 2008 and 2020 were in response to the global financial crisis and the pandemic, respectively. Both cutting cycles were designed to stimulate the economy following significant shocks. In contrast, this cutting cycle is about fine-tuning monetary policy in an effort to sustain current economic growth.
With the release of economic data recently, the economic outlook has become a bit more hazy. The posturing between the White House and the Fed has also complicated matters. Given these developments it is important to keep the following in mind:
Interest rate cuts have been expected -
The last few Summary of Economic Projections reports published by the Fed showed that rate cuts were likely this year - even as the number and magnitude anticipated have varied over time. The Fed’s latest projections show there could be two additional cuts this year.
Cuts are reversing the previous run-up in rates -
This rate cut is another step in reversing the rapid increase in rates enacted to counter the inflationary surge that began in 2022. Even as economic data appears to be softening, rate cuts are occurring against a generally positive economic backdrop.
Fed Chair Powell’s current term is scheduled to end in May 2026 -
Assuming he is not reappointed, a new Fed chair will be nominated by the President and confirmed by the US Senate. President Trump will likely select someone who supports lower rates at the Fed. While short-term rates are set by the Fed, long-term interest rates are driven by the market and economic forces. If the market questions the Federal Reserve's independence, long-term rates could rise and produce headwinds.
This latest rate cut is in line with the trajectory the Fed started in 2024, and signals the Fed's commitment to supporting economic expansion. So far, the market's reaction has been generally positive.
Lower rates generally benefit businesses and investors
Lower borrowing costs make it cheaper for companies to finance growth and reduce debt service expenses. Consumer spending can increase if mortgage and credit card rates decline, boosting demand for goods and services.
The last few Summary of Economic Projections reports published by the Fed showed that rate cuts were likely this year - even as the number and magnitude anticipated have varied over time. The Fed’s latest projections show there could be two additional cuts this year.
Portfolio implications
For diversified portfolios, history suggests that rate cuts typically provide support across asset classes, particularly in the absence of a crisis. While past performance is no guarantee of future results, stocks have often benefited from lower interest rates, which reduce the discount rate on future earnings and increase their present value. Bonds with higher coupons generally become more valuable as new issuance reflects lower yields, though the impact varies by sector and maturity. In contrast, cash yields typically fall, making cash less attractive relative to other investments.
What we are watching
The Fed is cutting rates when the stock market is already near all-time highs. While this is not typical, there have been cases during which this has occurred in the past. Under Alan Greenspan, the Fed cut rates three times in 1995 and 1996, calling the cuts "insurance" against economic slowdown. The Fed also made cuts in 2019 at market highs to address global growth concerns. Similarly, Powell described this most recent policy decision as "a risk management cut" due to the Fed’s view that “downside risks to employment have risen." Taking all of this into consideration, we remain cautious and focused on the potential unintended consequences of cutting rates while stocks are near all-time highs.
In conclusion, interest rate cuts are generally a positive development for long-term investors, although the current environment highlights the need to appropriately balance risk and reward.
If you would like additional insights or guidance, schedule a call.
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