Over the past few weeks, there has been a flurry of media attention around the Federal Reserve’s decision to cut interest rates by 25 basis points. This is the first time the U.S. economy has experienced a rate cut in over a decade. However, many consumers and investors are unaware if the rate change was necessary, why interest rates are important and what effect a future rate cut may have.
Although some experts don’t believe a rate cut was needed because rates were actually lower than they’ve typically been at this point in the economic cycle, both politicians and the market priced in a rate cut at the Fed’s August meeting. So if this rate cut didn’t occur, there was the potential for a massive upheaval in the bond market. Despite just experiencing a rate cut, the market is already starting to price in another potential cut in the upcoming year.
If the Fed chooses to ignore what the market has already priced in, there’s the potential for a large reset in the bond and equity market. If this happens, fixed income bond performance would decline and there would be a negative paper value loss which is when there’s an unrealized capital gain or capital loss in an investment.
With so many variables at play, it’s easy for investors to wonder what the “big picture” is for the Fed. It seems as though they’re projecting a wait and see strategy. Rates are historically low right now, so if something bad does happen they don’t have a lot of wiggle room to make significant rate cuts like they did a decade ago. During the 2008 financial crisis, rates were another 200 to 250 basis points above where they are now.
The economy is currently doing well, unemployment is low and consumer spending is up. However, it’s important for investors to remember that a recession is a natural part of the economic cycle, but not all recessions will be as bad as the one we experienced in 2008. When most consumers hear the word recession, they are often taken back to the Great Recession in 2008. During this time, the financial world was in distress and some large financial institutions went broke overnight, which caused the stock market to fall drastically.
Overall, it’s important for investors to keep an eye on the Federal Reserve because their main purpose is to help keep the U.S. economy humming along. The decisions they make on interest rates and monetary policy have an impact on how costly it is to borrow money, how businesses choose to hire and grow, employment numbers, and the overall economic well-being of our country.