Fed Rate Cuts

Amid the buzz about an upcoming rate cut, it's easy to overlook why it matters. Many believe it will boost stock prices and please Wall Street, but that view oversimplifies the true reasons and effects. Let's break it down.

What Happens When the Fed Cuts Interest Rates?

When the Federal Reserve(the Fed) cuts interest rates, it lowers the federal funds target rate—the rate banks charge each other for overnight loans to meet reserve requirements. This rate is critical because it influences other interest rates, including the prime rate, which banks charge their best customers. Lowering the target rate impacts everything from credit card interest rates to mortgage rates, rippling through the economy.

Why Does the Fed Cut Rates?

The Fed has several tools for managing monetary policy, including open market operations, the discount rate, reserve requirements, and interest on reserve balances. When the Fed cuts rates, its primary goal is to stabilize prices (control inflation) and stimulate economic growth. Lower borrowing costs encourage businesses and consumers to invest and spend, helping to fuel economic activity.

Potential Impacts of a Rate Cut

Lower interest rates can have both positive and negative effects:

Positive Impacts:

·       Lower Borrowing Costs: Reduced rates make borrowing cheaper for consumers and businesses, stimulating spending and investment, injecting capital into the economy, and fostering growth.

·       Economic Growth: Increased spending and investment generally spur economic growth, which can also boost stock market returns.

Negative Impacts:

·       Inflation Risk: Prolonged low rates can lead to excessive economic growth, driving up inflation and eroding purchasing power.

·       Increased Risk-Taking: Investors might take on more risk in search of higher yields, potentially leading to asset bubbles.

·       Impact on Retirees: Retirees who rely on interest income may reduce spending to avoid tapping into their principal, especially as the Baby Boomer generation transitions into retirement. This could reduce overall consumer spending, affecting the broader economy.

Historical Perspective on Rate Cuts

Looking back at the 14 Fed rate cycles since 1929, certain trends emerge. Although the historical data is limited, it’s revealing; in 86% of cases, the S&P 500 saw gains in the 12months following the initial rate cut. The exceptions—in 2001 and 2007—are still fresh in memory, but neither scenario mirrors today’s economic conditions. Understanding the Fed’s current motivations may provide better insights into where the market could be heading.

Beyond the Fed’s Actions

While the Fed's rate decisions are significant, other factors also influence the market’s direction:

·       The Economy: A resilient economy is a positive indicator for the stock market. The Fed’s focus on controlling inflation may reflect confidence in the economy’s underlying strength.

·       Investor Sentiment: High investor confidence can be a double-edged sword. While optimism can drive markets higher, it can also lead to rapid downturns if the economy falters.

·       Valuations and Earnings: Despite high valuations, we're in a period of earnings acceleration, where many companies report stronger quarterly earnings. This growth could justify high market valuations and drive stocks even higher.

Looking Ahead

We continue to monitor themarkets and vigilantly watch our portfolios. As you know, we hold a monthlyinvestment committee meeting to review macro trends and adjust strategy asnecessary. We continue to do this to serve you. Please let us know if you haveany questions.

In gratitude,

Brandon Hatton on behalf of

The Conscious Wealth Investment Committee

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