The Fed Made Its Move: Rate Cuts and Market Momentum

The Rate Cuts and The Economic Future

The Federal Reserve finally did it—they cut interest rates for the first time in four years. Before their meeting, it was widely expected that a cut was coming, but there remained some mystery as to the cut’s size. While only a quarter-point cut was anticipated, they opted for a more aggressive half-point cut in a move similar to their inflation-combatting tactics. Pre-announcement speculation suggested that a half-point drop would signal concerns about the economy weakening—a bad sign for markets. However, the stock markets reacted oppositely, rallying sharply after the cut was announced.

Looking ahead, two more quarter-point rate cuts are currently expected in 2024 as well as a series of four quarter-point cuts in 2025. In 2026, it’s expected that two further cuts will follow.  This would bring the Fed Funds rate down to around 3%. While we don’t necessarily agree with the anticipated magnitude of the expected cuts, we can assume that they are directionally accurate – short-term rates are likely to move lower in the next year or two. 

Meanwhile, inflation remains slightly above the Fed’s 2% target, with the consumer price index and personal consumption expenditures lingering around 2.5% and continuing to trend downward. It is possible the Fed could pause rate cuts or even reverse course and raise rates if inflation happens to take hold again. However, their aggressive half-point cut suggests they feel confident that the economy is softening and lower rates are warranted.

Stock Market Snapshot

Despite indications of a slowing economy, the stock market seems virtually unstoppable and continues to provide robust returns. The S&P 500 returned over 5% in Q3 and is now up more than 20% year-to-date. We remain cautious as valuations remain stretched. Certain areas of the market look more attractive than others, depending on sector and market capitalization. We expect small caps – companies requiring loans to grow – to outperform large caps in the coming months as interest rates continue to decline.

In terms of fixed income, interest rates for terms longer than three months have already adjusted, so we don’t anticipate much further downward movement. While fixed income has posted solid returns this year, future gains may be somewhat limited. With shorter-term rates dropping, investments in money markets and T-bills will earn lower interest and therefore garner fewer “real” returns when inflation and taxes are considered. Now could be a good time to explore other options for income and safety, whether that means locking in current rates or considering alternative strategies with better potential returns.

Election Effects

Many may be concerned about how next month’s election will affect the economy, but historically elections have a limited impact on the markets. This year should be no different. The election outcome may affect different sectors, but the overall market impact is likely to be muted. However, markets dislike uncertainty, so a post-election rally could occur once the results are in.

The Bottom Line

If you are concerned about the stock market and seeking returns beyond what fixed-income investments can offer, this may be an opportune time to explore strategies participating in market upside while limiting downside impacts. Many investors have become complacent after enjoying the strong returns of the stock market since the beginning of 2023. We will caution risks abound; do not put your retirement plan in jeopardy by taking on an inappropriate amount of risk – whether it be too little or too much. Call us if you would like to review your portfolio and ensure you remain on track to enjoy a worry-free, secure retirement: 952-460-3290.