The Federal Funds Rate has been held steadily north of 5% for over a year. At the September meeting, the FOMC not only cut rates, but more importantly, signaled a faster pace of easing policy than was projected at June’s meeting. Rate cuts can be a sign of easing the tightening cycle (taking your foot off the break to coast), OR that there is a looming recession. Rates can be cut without a recession present, in fact they did so in 1971-72, 1984-86 and 1995-98. Chart 4 on the left illustrates from 1966 to present how stocks and bonds have performed on average in each scenario. We believe the left image of a Fed cut with no recession is more likely to be realized.
Given the level of the initial cut and the FOMC’s forecast of future rates, our current takeaway is that these actions are more about signaling to the market that the risks are subsiding on the inflation front and that they are trying to get ahead of the employment landscape before it turns for the worse. While additional risks exist, we believe this is the case more than indicating looming deeper stress in the economy. Of course, this is always subject to change as new data arises.
Businesses make their strategic planning decisions on when to invest in operations for future growth, based on the return on investment being greater than the cost of capital. While lower interest rates take time to work through the system, it spurs economic activity. This can be a catalyst for companies, leading to a positive impact on stock prices over time.
From a bond perspective, the yield curve is no longer inverted, meaning that for the first time in 26 months (the current inversion is the longest on record), the yield on a 10-year Treasury bond is greater than the yield on a 2-year Treasury bond. An inverted yield curve signals investors’ pessimism about the economy, whereas a normal yield curve that is upward slopping signals future optimism. Recall, as rates go down, bond prices go up due to the inverse relationship that exists. Bonds continue to hold an important role in portfolios where warranted. When appropriate given a client’s risk tolerance, we have been adjusting the amount of bonds held in accounts and the composition of the holdings underlying.