The US Federal Reserve just gave its clearest signal yet that rate cuts are coming.
At the central bank’s meeting Wednesday, Chair Jerome Powell said his focus now is deciding when to reduce benchmark interest rates in 2024. That ignited a cross-asset rally, sending global share prices higher and the yield on 10-year US Treasuries dipped below 4% for the first time since August.
Investors are now pricing in six quarter-point rate reductions in 2024 by the Fed, twice the three pencilled in by the central bank. Of course, Powell also said that officials may hike again if price pressures return. What does all this mean for your money?
Here’s what you need to know:
Will my investments be impacted?
Right after Powell’s speech, everything from global stocks to corporate bonds surged higher, for the best Fed day across all asset classes in almost 15 years.
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Interest rate cuts are generally a positive catalyst for stock prices, especially growth companies whose value comes from their future earnings potential. So-called risk assets, including lower-quality tech stocks and high-yield bonds, should receive a boost.
“Assuming this doesn’t mean the Fed is now worried about a recession, it has given investors the green light to keep buying risk assets with both hands,” said Matt Maley, chief market strategist at Miller Tabak + Co.
Assets around the world may also benefit from rate cuts in the US.
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“A textbook dovish pivot response in stocks and the US dollar should bode well for Asian equities,” said Chamath De Silva, a senior fund manager at BetaShares Holdings in Sydney. “The exception might be Japan, which will have to deal with big yen strength.”
What about the 60/40 portfolio?
The classic portfolio structure of 60% stocks and 40% bonds has had a rough time recently, but may be poised for success now.
For decades, this portfolio produced strong risk-adjusted returns. The idea had long been that stocks provide growth and bonds provide relative stability, on the assumption that the two are not tightly correlated.
That stopped working as the Fed jacked up rates. Both stock and bond prices fell and last year, and portfolios with a 60/40 blend actually dropped 17%, their worst performance since 2008. Some researchers have even found that over time, certain all-stock portfolios beat those blended with bonds in both money made and capital preserved.
Fed cuts next year would likely boost stock prices and send bond yields lower. But a lot depends on why they’re cutting. If a recession hits, things will be tricky. But if the Fed cuts rates based on inflation normalizing and pulls off a soft landing, investors may be wise to load up on bonds now, said Elliot Pepper, financial planner and director of tax at Northbrook Financial in Baltimore.
What does this mean for my cash savings?
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It’s been a great period for returns on cash, with rates on many high-yield savings accounts in the US at more than 4%. Meanwhile, Australia boasts a top savings rate of around 5.7%, and in New Zealand, the rate on a one-year term deposit has crossed 6%.
But rate cuts may end this golden era, as banks tend to move their yield offerings alongside benchmark interest rates. Still, competition between banks for deposits may prevent them from reducing rates too quickly.
When it comes to exchange rates, it depends on the currency. For the US dollar, it’s not so good — every group-of-10 currency rose versus the dollar on Wednesday, with the gains continuing in Asia on Thursday. Japan’s currency strengthened to levels not seen since August and advanced further early Thursday. The South Korean won and Malaysian ringgit gained more than 1% against the greenback in a sign of strength among emerging markets currencies.
What happens to mortgage and credit card rates?
Homebuyers may finally see some relief in 2024. Mortgage rates usually decline alongside Fed cuts, which would help ease the housing affordability crisis around the world.
Mortgage rates in the US just fell for a fourth straight week to the lowest since July, with the contract rate on a 30-year fixed mortgage now at 7.07%.
Costs for credit card users will also likely decrease, since card issuers typically use the Fed-influenced prime rate as a base to charge interest plus an additional spread. That would help consumers struggling with debt.
How do Fed decisions influence rates across the world?
Higher US rates make dollar-denominated assets more attractive, sucking money out of other markets and causing their currencies to fall. Some countries have had to defend their currencies against a strong greenback, adding to inflation pressures and making it harder to pay back debt that was issued in dollars. A Fed pivot may reverse that trend.
Some central banks and monetary authorities also move in lockstep with the Fed, including Hong Kong whose currency is pegged to the US dollar. But European Central Bank President Christine Lagarde said on Thursday that policymakers shouldn’t get complacent on the battle against inflation just yet, while her Bank of England counterpart, Andrew Bailey, observed that “there is still some way to go” in the fight to tame consumer prices.
