In late July, the Federal Reserve announced an interest rate cut of 25 basis points,1 which came as no surprise to most investors as it had been widely forecasted and even encouraged for weeks. At last week’s Jackson Hole Symposium, Fed Chairman Jerome Powell indicated the possibility of even further rate cuts this year to support the expansion of the U.S. economy.2 However, different types of investors might disagree over whether this is a cause for celebration or concern.
Short-term investors likely cheered news of the newly lowered rate to achieve temporary gains. As much as we don’t like to acknowledge it, much of the trading on any given day is based on algorithms and rules-based strategies that attempt to squeeze out short-term benefits after taxes. Long-term investors, on the other hand, likely are not applauding lowered rates because it means the Fed believes economic data has weakened enough to warrant an intervention.3
In the last several months, U.S. manufacturing has slowed 4 and global trade volumes have decreased,5 with much of this being caused by the trade dispute between the U.S. and China.6 This has caused interest rates to fall to the point that now even some high-yield (junk) bonds are trading at negative interest rates in Europe.7
These international developments are trickling into the U.S. markets. Many are now expecting 2019 earnings to be soft, especially following 2018’s earnings, which were very strong.8
With all of this in mind, it’s still difficult to predict the timing or size of a decline because pullbacks happen frequently throughout a typical year. In May, the market fell 6.6 percent from what was an all-time market high. We recovered though and hit a new market high. As of Aug. 27, we are down 6.6 percent from that high point.9 These are fairly normal market corrections, and it is difficult if not impossible to determine which correction will develop into something larger. To further convolute matters, over the last two quarters the stock market and bond market have often been at odds with one another on whether we are headed toward a recession.10
As of now, there is no significant action that long-term investors should be making in reaction to lowered interest rates other than regular rebalancing to strategic targets. We would caution rooting for further interest rate declines. While this might help markets for a few days, your cash and bond investments are left at interest rate levels that are producing negative returns after inflation and taxes.
Sources:
1. CNBC.com – Here’s what the Fed rate cut means for you
2. NPR – More rate cuts? Powell says Fed is ready to help economy grow amid trade tensions
3. CNBC.com – Fed to cut rates for first time since 2008
4. Yahoo! Finance – Weak economic data, tariff concerns weigh on stocks globally
5. World Trade Organization – Global trade growth loses momentum as trade tensions persist
6. CNN.com – What Trump’s China trade war means for you
7. Bloomberg – Sub-zero yields start taking hold in Europe’s junk-bond market
8. CNBC.com – Corporate profits expected to be highest in seven years, but that may not help stocks much
9. Yahoo! Finance – S&P 500
10. CNN.com – The bond market is freaking out. Here’s why that matters
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