The Informed Investor
In recent weeks, you have likely heard increased discussion in the media and financial news about the Federal Reserve cutting interest rates in the near future. What are the immediate and longer-term implications?
The Federal Reserve was originally created with a dual mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” In other words, the stated goal of the Fed is to keep unemployment low and inflation in check. They attempt to achieve this goal primarily through controlling the federal funds rate, which is the interest rate that banks charge when lending to other banks overnight. The reason this rate is significant is because the Fed can also conduct what is called “open market operations,” or buying and selling government bonds in order to influence interest rates to ensure they remain within a range of the federal funds rate that they set. This rather complicated process is important to understand in order to recognize the impact changes to the federal funds rate can have on the economy and stock and bond markets.
So back to the original question, what does the current speculation mean for the economy and markets going forward? During the Fed’s last meeting in June they discussed potentially cutting the federal funds rate (currently 2.25% – 2.50%) sometime this year if inflation remains low and the U.S. economy continues to soften. The Fed’s expectations for inflation have deteriorated, which means they are likely to make an attempt to stabilize the rate if the deterioration continues. The stock market has reacted positively to this news because such a change should have a stimulating effect on the economy. Investors are now anticipating the Fed will cut the rate by 0.50%, and this change has already been factored into the movements of the stock market. Whether the Fed follows through, as investors are anticipating, will likely play a large role in the direction of the markets from here.