Why is the Fed Cutting Interest Rates?

The stock market has experienced a 10-year bull run, unemployment is under 4%, the most recent 12-month inflation rate through June 2019 measured at 1.6%, and the housing market in most of the country is healthy with increasing home values.  Under normal circumstances, these statistics sound great.  So why did the Federal Reserve cut interest rates for the first time in 11 years and additional rate reductions are anticipated?  

Interest rates are typically lowered to spur growth in the economy.  Economists are concerned that US gross domestic product (GDP) growth will continue to slide after it moved from 3.1% in the 1st quarter of this year to 2.1% in the 2nd quarter of 2019.  This leads us to our next question - what is causing the economy to slow with fears of recession to creep up on the horizon? 

The US trade war with China is the main culprit of the global economic slowdown.  Several months ago, the risk of higher tariffs (taxes placed on imported goods) from China seemed to be receding.  However, trade negotiations between the  2 countries have soured as the US raised tariffs from 10% to 25% in May on $200 billion dollars of Chinese products...in response China raised tariffs on US goods coming into their country.  Recently, the US accused China of devaluing its currency, the yuan.  With a weaker yuan, Chinese goods become cheaper overseas and helps to offset the tariffs imposed by the US.  The constant retaliation by the world’s two largest economies causes uncertainty and angst for companies and other countries making them think twice before making investments.  

While understanding why rates dropped is important, even more pertinent is how this could impact you.  For those with a mortgage, it may be a good time to consider refinancing your loan.  30-year mortgage rates were recently at 3.625% after being close to 5% in November, 2018.  15-year mortgage rates dropped to 3.20% in July from their recent high of 4.28% in November, 2018.  If you are borrowing money these lower rates are beneficial, however in contrast if you are a saver and have CDs or money markets, you will most likely see the interest rate you receive on your next CD to be lower as banks lower their deposit rates.  Money market rates which are not typically guaranteed like a CD rate will most likely fall after approaching 2.3% recently.  On a positive note, if you hold bonds or bond funds in your current portfolio, you have most likely seen the value of those bonds rise in 2019 as existing bonds historically gain value when rates are lowered.  New bonds coming to market will be less appealing with lower interest rates paid out to the bondholder.  Historically, lower interest rates have boosted the stock market as investors shift money from the bond market to the equity markets. 

What does the future hold for interest rates?  Economists are predicting additional rate cuts by the Federal Reserve in the short-term.  Over the long haul, it is difficult to see interest rates increasing dramatically in the US.  The US has some of the highest interest rates in the developed world so even though historically our rates are still very low, they are desirable to investors globally.   

In short, some will find lower interest rates to be a positive - creating opportunities to save money - others will find the results not be as desirable, especially for those seeking income from their CDs and money market accounts.