What impact will the Fed rate cut have on stocks, bonds and cash?
Even before the panic triggered by new data from the US economy and Japan rocked global markets, bets were rising that the US central bank would start cutting interest rates in the autumn. Now it seems that an easing of the Fed’s monetary policy is inevitable. Ben Carlson of investment firm Ritholtz Wealth Management looks at what lower rates could mean for stocks, bonds and cash.
“I have to disappoint at the outset those who attach great importance to the Fed’s monetary policy – in my view, it has less impact on markets than is often assumed. The stock market is not directly affected by the central bank, its influence is mainly seen in short-dated bond yields,” Carlson says.
More important than the Fed’s actions themselves, Carlson says, is the reason why they are occurring, namely macroeconomic realities and their prospects. The main reason for the expected drop in rates is declining inflation, which is positive news for the economy and the markets. While fears of a recession are growing, economists believe that this scenario is not yet likely.
“History shows that U.S. stocks have never experienced a loss in the five years following the first rate cut since the 1970s. A loss has been registered only three times in the three years following a rate cut – during the bear market of the 1970s, after the bursting of the tech bubble, and during the Great Financial Crisis,” Carlson recaps. However, if the U.S. economic outlook were to worsen, the stock market would be negatively affected, as shown by comparing the performance of the S&P 500 index after the start of the rate-cut cycle in periods with and without recessions.
Monetary policy has the greatest impact on cash held in savings accounts and in instruments such as Treasury bills, where changes in rates are reflected almost immediately. In the case of bonds, the shorter the maturity period, the faster and more responsive they are to changes in monetary policy. For example, the yield on 2-year US government bonds has fallen from around 5% to less than 4% since the end of May.
“For the stock market, the Fed’s actions are not fundamental, but for bonds it is already important to follow the rhetoric of central bank officials. In the case of cash, the monetary policy settings are then key. However, investors are now in a relatively calm situation because they do not have to rush to rebalance their portfolios at the current level of monetary policy tightness. Even if 10-year bond yields differ by a percentage point, current yields are still sufficient to protect against inflation,” concludes Ben Carlson.
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