August 13, 2019
7 Takeaways from the FED’s Decision to Cut Interest Rates
By Vance Albitz, CFP®
On 7/31/19, the Federal Reserve cut interest rates ¼ percent. This was the first interest rate cut in over a decade. The market’s reaction looked something like this:
(Cartoon from Howard Marks memo: “On the Other Hand”)
Here are 7 takeaways:
1. The FED has seemingly changed their approach to being “data dependent” to being “headline dependent.” Lowering rates was not because of weak current economic numbers but rather to combat projected future weakness.
2. The widespread belief by economists and investors alike is: Weak economy -> rate cuts -> economic stimulus -> stronger GDP -> higher corporate profits -> higher stock prices. This logic remains the basis for the FED’s decision to cut rates.
3. Low rates stimulate the economy but there is a thing as an economy becoming too hot. The principal worry is excessive inflation. While some inflation is a good thing, too much isn’t. It’s generally accepted that too much market power in the hands of sellers of goods result in a swift rising of prices. Too much inflation imposes a hardship on people living on fixed incomes, since their costs increase rapidly while their incomes do not. Also, low-income households typically don’t have the means to hedge against inflation that high-income ones do, such as through investments in equities and real assets. Therefore, one can conclude an overheated economy may help the rich but the poor.
4. Low rates can lead to investment in undeserving companies and shaky securities, encourage the use of excessive leverage, and create asset bubbles that eventually can burst.
5. Mostly, when interest rates are low, central banks don’t have at their disposal as much of their best tool for stimulating economies: the ability to cut rates.
6. From an economic standpoint, low rates reduces the cost of borrowing, lifting demand for things that are often bought on time or leased, like cars, homes and appliances. Further, low rates translate into lower monthly payments on floating-rate mortgages, leaving consumers more disposable income to spend. This is one reason a rate cut stimulates the economy.
7. Jerome Powell and the Federal Reserve have an extremely difficult job. There are positives and negatives of changing rates; all of which can and do lead to second guessing.
Further questions to consider: can the Fed actually sustain expansions and prevent recessions? Is it their job to do so? Are recessions avoidable or merely postponable? Should recessions occur naturally or be postponed unnaturally? Should we be happy to see the Fed trying to prolong the economic expansion and the bull market when they’re already the longest in history? Should it try to produce perpetual prosperity and permanently ward off a correction? Are there risks in its trying to do so? There is not a clear answer to any of these questions now; only hindsight will be 20/20.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.