3rd Quarter 2024.
Market Review
Performance Driver Review
Market Perspectives
With two weeks left in the Third Quarter of 2024, the Federal Reserve (the Fed) cut interest rates for the first time in over four years. This was a far cry from the beginning of 2024 when the consensus view of market professionals was for several rate cuts throughout the year. That said, when the cut finally came, the Fed reduced its benchmark rate by 50-basis points as opposed to the 25-basis point cut that some pundits were predicting.
Markets and dinner tables alike were buzzing with conversation both leading up to and after the cut. In fact, it’s been almost peculiar how many people both inside and outside of the financial profession are talking about the Federal Reserve and interest rates – everyone is rate watching. This is likely because of how much the average consumer has been feeling the higher rate levels both on the asset and liability sides of their personal balance sheet.
So, the consumer is feeling the high-rate levels, and the Fed just cut rates from 5.25% to 4.75%, surely the consumer (or the investor) is going to feel some of that effect!1 Well, it’s not quite that simple… it’s time to frame up the impact of these moves and future moves by the Fed on the consumer’s personal balance sheet and investment portfolio. The most important baseline to keep in mind is that the Federal Reserve only has direct influence on short-term interest rates while different forces in the market generally influence long-term interest rates.
Savings
The spot that investors are most likely to see the direct impact of rate moves is in their savings account or cash management vehicles. Generally, these safe cash vehicles set the rates they pay using the Federal Funds Rate as a guide. When the Federal Funds Rate moves, the cash management rate moves almost instantly. This is the exact reason WoodTrust explained in its 3Q2023 Market Perspectives that some investors may want to review excess cash balances and consider longer-dated bond portfolios to lock higher yields in for several years. To put it simply, if rates go low, the yield on your savings will be the first to go.
Loans
Take a break from the asset side of the consumer’s balance sheet to consider liabilities, or most importantly, loans. This is the reason the average consumer is hyper-focused on Fed cuts. In the last couple years, consumers have felt the effect of elevated financing costs in actual interest paid and by way of delayed purchases due to the relative expensiveness created by higher interest payments.
While many consumers have eagerly awaited a Fed cutting cycle in hopes of lower financing costs on a new home, car or business venture; in reality, the connection is a bit less direct. This goes back to the baseline of this piece: “the Federal Reserve only has direct influence on short-term interest rates…” Most loans tend to be medium- or long-term financing instruments. Rates on these products are not priced directly off the ultra-short-term Federal Funds Rate. Instead, they tend to be priced via guidance from the yield on longer-dated risk-free bonds. While short-term rates are moving downward, medium- and long-term rates may not budge; therefore, rates on things like 5-year auto loans or 30-year mortgages may be slower to adjust.
Bond Market
Back to the asset side of the balance sheet, but now the discussion is focused specifically on consumers with an investment portfolio. Starting with the obvious, surely rate cuts must affect the bond market! While the simple answer here is yes, the more honest one is that rate cut expectations drive the bond market. Believe it or not, despite the first Fed rate cut happening a few weeks ago, the yield on the 10-Year Treasury Note actually peaked back in October of 2023 (once again, this harks back to WoodTrust’s 3Q2023 letter about buying a longer dated bond portfolio). The 10-Year’s yield dropped from nearly 5.00% at that time to roughly 3.75% to end the quarter-evidence of the bond market moving ahead of the Fed, noting easing inflation and correspondingly finding confidence in bidding to lock in longer yields.
After the first cut, history says that the 10-Year typically tends to hold up pretty well. Occasionally, there is a brief drawdown during the beginning of the cutting cycle, but by 12 months after the first cut, the return from the 10-Year Treasury Note has been positive in all of the last six cutting cycles.2
Stock Market
The stock market has the most complicated connection to Federal Funds Rate adjustments. While a case can be made that any reduction in rates should lower the cost of capital for any publicly traded company, that does not mean that stocks simply go up when there is a rate cut. The main reason for this being the rate cut is often connected to a host of other data estimating the strength of the U.S. economy, which the stock market is also pricing in.
Looking again at history, during the last six Fed cutting cycles, stocks were positive 12 months after the first cut four different times. Typically, the stock market is positive if the cut is during an economic expansion as opposed to a recession.3
In Summary
While everyone has been waiting for a rate cutting cycle, the initial effects of these cuts may not be all they anticipated. When it comes to your investment portfolio, a diversified collection of stocks and bonds has historically been capable of navigating a rate cutting cycle. Bonds have served as a buffer in the event of a weaker economic period, especially when starting yields are high, and stocks tend to offer upside as the economic situation solidifies. With an appropriate asset allocation, there is no reason to stray from your investment discipline. As always, we thank you for your trust and look forward to our meetings with you in the near future.
1These percentages reference the low end of the Fed’s target range.
2This is referencing a total return figure.
3The S&P 500’s price return is used as the reference index here.
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