What the Federal Reserve cutting cycle means for physicians
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Key takeaways:
- The Federal Reserve lowers interest rates to stimulate economic activity.
- Falling rates mean a potentially new investment environment that brings new opportunities for investors.
After an historic rate hike cycle that was the fastest on record and largest in decades, the Federal Reserve announced its first rate cut since 2020 this past September.
The Federal Reserve (Fed) began lowering rates in a measured manner to maintain a healthy, growing economy and jobs market without fueling additional inflation, a scenario referred to as a “soft landing.”
During the Fed’s hawkish period starting in March 2022, U.S. inflation has dropped from a more than 40-year high of 9.1% down to 2.5%. While the latest inflation number remains above the Fed’s 2% target, “the committee has gained greater confidence that inflation is moving sustainably toward 2%, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” according to the latest Fed statement.
When the Fed lowers interest rates, it has a broad ripple effect on the economy, impacting everything from consumer spending and borrowing costs to business investment and stock market valuations.
Here is a breakdown of some of the major effects.
Cheaper borrowing costs
For consumers: Lower rates mean lower interest on loans like mortgages, auto loans and credit cards. This often encourages more borrowing and spending, as consumers find it more affordable to finance purchases or refinance existing loans.
For businesses: Businesses also benefit from reduced borrowing costs, making it cheaper to finance expansions, invest in new projects or refinance debt. This can lead to increased business investment and job creation, which can boost the economy.
Economic growth, consumer spending
Lower interest rates generally increase spending and investment, stimulating economic growth. This is often the goal of the Fed during times of economic slowdown, as greater spending can support gross domestic product growth, reduce unemployment and improve overall economic health.
When borrowing is cheaper, consumers may feel more confident about spending rather than saving. This increase in consumer spending can help drive demand for goods and services, which further fuels economic growth.
Impact on inflation
By lowering rates and encouraging spending, the Fed aims to prevent deflation and keep inflation at a target level (usually around 2%). However, prolonged low rates can lead to inflationary pressures, especially if demand outpaces supply.
Effects of changes to the Fed funds rate also spill over into financial markets. There is even an old investing mantra that goes, “Do not fight the Fed,” meaning it would be wise to align your investment choices with the actions of the Fed.
Rate cuts are usually a response to economic slowdowns. If cuts are early in a cycle, riskier assets like stocks may perform well. Late-cycle cuts could signal deeper economic issues, where defensive assets might be safer.
Boost in asset prices
Stock market: Lower rates reduce the appeal of safer investments — like bonds — which can push investors toward higher-yielding, riskier assets, such as stocks. In addition, lower rates can boost corporate profitability by reducing interest expenses of companies, which often leads to higher stock valuations.
Growth stocks: Rate cuts make borrowing cheaper, which can be a boon for growth-oriented companies with higher borrowing needs. Sectors like tech and consumer discretionary often benefit.
Dividend stocks: With lower returns on fixed-income investments (like bonds), dividend-paying stocks become attractive for income-focused investors, especially those in sectors like utilities and real estate.
Real estate: Mortgage rates generally decrease when the Fed cuts rates, making homes more affordable and increasing demand in the housing market. This can lead to rising home prices and increased real estate investment.
Real estate investment trusts benefit from rate cuts as these typically have significant debt to finance property purchases. Lower borrowing costs can increase profitability. In addition, real estate investment trust dividends may attract income-seeking investors during low-rate periods.
Bond market impacts
When the Fed cuts rates, existing bond prices generally rise, as newer bonds will likely offer lower yields. This benefits bondholders, but new bonds offer lower interest, which can push investors toward equities or other assets in search of higher returns.
Long-term bonds: Bond prices and interest rates have an inverse relationship. When rates fall, bond prices generally rise, which benefits long-term bonds more than short-term bonds.
Investment-grade and high-yield bonds: High-yield bonds can be attractive if the economy is improving, as lower rates decrease default risks. However, safer, investment-grade bonds will likely offer lower yields in a low-rate environment.
Alternative assets
Rate cuts may also open opportunities in private equity, infrastructure and other alternative assets, which can benefit from increased borrowing and economic expansion.
Overall, the Fed lowers interest rates to stimulate economic activity, but the long-term effects depend on how consumers, businesses and markets respond.
Falling rates mean a potentially new investment environment that brings new opportunities for investors. It is crucial for investors to review their asset allocations and have investment strategies in place to align portfolios for times ahead.
References:
Mandell and OJM Group partners are pleased to announce the publication of our newest book, Wealth Strategies for Today’s Physician: A Multi-Media Playbook. The playbook’s innovative format features more than 90 links to videos and podcast episodes to enhance important financial topics for physicians. To receive a free print copy or ebook download, text HEALIO to 844-418-1212, or visit www.ojmbookstore.com and enter code HEALIO at checkout.
Pound J. Here’s what changed in the new Fed statement. www.cnbc.com/2024/09/18/fed-rate-cut-heres-what-changed-in-the-central-banks-statement.html. Published Sept. 18, 2024. Accessed Dec. 3, 2024.
US inflation rate (I:USIR). ycharts.com/indicators/us_inflation_rate. Accessed Dec. 3, 2024.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon practicing at Northwestern Medicine in Warrenville, Illinois. He can be reached at sanjeevbhatia1@gmail.com or @DrBhatiaOrtho. David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com, where Bob Peelman is a partner and director of wealth advisors. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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