The Federal Reserve is holding its two-day meeting on September 17-18. At the conclusion of the meeting, the Fed is expected to announce a quarter-point interest rate cut (25 basis points). In advance of the decision, the markets are implying a 1.81% funds rate following the September meeting. This would be about 30 basis points below where the benchmark Fed funds rate sits now.
Just like after the Fed cut rates after their last meeting in July, the possibility of additional rate cuts is already being debated. There are some who would like the Fed to be more aggressive. The President of the St. Louis Federal Reserve, James Bullard, said the Fed should cut rates by half a point (50 basis points).
But as an investor, you can’t fight the decision. You just have to plan and prepare. In this article, we’ll give a quick review of the issues surrounding a rate cut and the steps you can take to prepare your portfolio for a rate cut.
The Case for a Rate Cut
Supporters of a rate cut point to the continued malaise plaguing the global economy. The European Central Bank (ECB) has already introduced a negative interest rate policy. In addition, the ECB will be engaging in their form of quantitative easing (QE). All of this is being done in an effort to spark growth. However, as Europe continues to struggle, it begins to affect U.S. multinational companies that have operations overseas.
The markets are also still skittish about the ongoing trade war with China. Although there remains optimism that some form of a deal will get done, the longer that it takes to get a deal done, the more it weighs on the market.
Finally, there are those who are concerned about softening conditions in the United States. Although job growth remains strong, there are signs of softening. The markets have been spooked recently as the yield curve has inverted. Politics also plays a factor as the U.S. approaches an election year and there is no appetite for a recession. In July, Federal Chairman Jerome Powell cited the Fed’s inability to get inflation up to their 2% benchmark level as a reason for cutting rates.
The Case against a Rate Cut
Those that argue against a rate cut point to strength in consumer spending and a stock market that recently hit record highs as an indicator that this is not the time to be adopting a more accommodative monetary policy. Rate doves are also concerned that cutting rates now will reduce the ability of the Fed to jump-start the economy in the case of a recession. Typically interest rate cuts are only made when the economy is in a recession. Therefore, pre-emptively cutting rates may reduce the Fed’s ability to counteract a recession. While interest rate cuts are not the only tool the Fed has at their disposal, they are one of the more benign.
How to Invest for Lower Rates
For starters, and I know this is stating the obvious, cash is not king. Declining interest rates are a disincentive for savers. So you might as well put your cash to work. One thing that makes this interest rate cut unusual is that typically interest rate cuts occur when equities are falling because they signal weakness in the economy. However, right now the Fed is cutting rates when the economy is still showing strengths by most accounts. For growth investors, they may not have to change a lot about their strategy. In fact, they may find that a rate cut will give a boost to some stocks that may seem overvalued.
However, if you are a value investor there are opportunities. You just have to be selective. Different sectors perform better when interest rates are falling. Utilities and health care are defensive sectors that tend to do very well when interest rates fall. Also, declining interest rates makes dividend stocks more attractive to value investors. While investors may not be able to get a return from a savings account and other fixed-income holdings, a high-yield dividend stock may be a better approach to getting some cash without having it tied up in a certificate of deposit.
More aggressive investors may look to gold and other precious metals. When the dollar is weaker, as it will be when interest rates are low, gold rises in value.
More conservative, income-oriented investors can look at locking in the higher dividend yields from high quality, investment-grade long-term bonds.
These are Unusual Times
The major stock exchanges continue to climb, and if interest rates fall again they will be set to go even higher. The U.S. economy remains relatively healthy while the global economy continues to fall. Putting politics, and your own personal feelings aside, a rate cut is likely to happen. While growth investors may not have to change much about their strategy unless the U.S. economy dips into a recession. However, value investors can take some strategic steps that will put their cash to work with some conservative investment opportunities.