The Fed Cut, Now What?

The Fed Cut, Now What?

As was widely expected, the Federal Reserve reduced the Federal Funds Interest Rate by 0.25% on July 31. Citing slowing global growth, weakening business investment, declining exports and a soft housing market, the Fed is trying to maneuver the economy through an economic soft patch. However, the Fed stopped short of suggesting a series of interest rate cuts, meaning this could be all we get. This was a disappointment to many, sending markets lower after the news. However, taking a bit of a contrarian view, I am happy they did not detail a longer-term plan for continued rate cuts. In essence, the Fed is sticking to its recent mantra and remaining data dependent.

On many fronts the U.S. economy did not warrant an interest rate cut. Employment is strong, consumer spending is strong, and economic growth is above trend. However, it is the negative change in growth that spawned the cut. Based on data available to the Fed today, it is very possible that economic activity continues trending negatively as the U.S. embarks on further trade negotiations. 

As if right on cue, two days after the rate cut, President Trump announced a further round of trade tariffs on Chinese imports, beginning September 1st. When the newly announced tariffs take place, all goods imported from China will have an additional tax. These additional tariffs will negatively impact global trade. As such, news of the tariffs sent stock markets and interest rates immediately lower. Trade negotiations remain the single most important uncertainty impacting markets. A deal could coalesce any day, but in the meantime, increased trade tensions could force the Fed to reduce interest rates even further over the remainder of the year.

In many respects the Federal Reserve has very few bullets in their gun. With interest rates so low, they lack some of the firepower normally available during recessions. It appears that the Fed is trying to get in front of an economic slowdown. These “insurance” rate cuts are like firing a warning shot hoping to scare off an attacker. It may just work, but the risks are mounting if growth does not reaccelerate.

AllegiantPA Economic Dashboard Portrait August 2019Most importantly, what does this mean to investors? The hope is that the Fed’s more accommodative stance will help spur economic activity. Specifically, the Fed is looking for a strengthening in business investment and residential investment. These were the weak areas in the latest GDP report (read our Features article to find out more). If lower interest rates succeed in stimulating investment, then economic growth could rebound toward 2018 growth levels. This would be a positive for stock markets and is worth watching closely. If unsuccessful, a recession could hit in the next couple of years.

With so many important changes impacting markets, the team at Allegiant is diligently examining the data in order to alert you if and when it requires changes to the investment strategy. As always, conversations about your income and cash needs over the coming months and years help as we evaluate how to prudently invest your portfolio. 

If you would like to see more data and charts about the economy and various financial markets, please click here to view our Monthly Insights book.

Benjamin W. Jones, CFP®, AIF®
President, Chief Investment Officer, Principal