As expected, the Federal Reserve reduced the Federal Funds rate by 0.25% today, the first rate cut since December 2024. What can investors expect going forward following the reduction in short-term interest rates? First off, some of the impact is “priced in” in advance of the actual rate cut, as investors and financial markets are forward-looking. That being said, there are some general reactions to expect:
Short-Term Savings and Liabilities
- There will be a very tangible effect here – the yield or interest on short-term savings vehicles such as money market funds will drop relatively quickly to reflect the lower rate from the Federal Reserve.
- Floating-rate loans (i.e. home equity lines of credit, securities-based loans, credit card loans) are often based on Secured Overnight Financing Rate (SOFR) (replaced LIBOR), which tracks Federal Funds rate closely. There should be a reduction in the interest on floating rate loans.
Mortgage Rates
- Fixed rate mortgages are the dominant structure in the United States, and the impact of lower Federal Funds rate can be limited on 15-year and 30-year mortgages.
- These types of fixed mortgages are based off the yield of longer-term Treasuries, plus a risk spread associated with underwriting and issuing the mortgages.
- Longer-term Treasuries reflect expectations for future economic growth and inflation and are not set by the Federal Reserve.
- This is also an example of investors pricing-in future events: 30-year mortgage rates hit their lowest level of the year before the interest rate cut was announced.
Stock and Bond Investments
- The impact on the stock market can vary- certain sectors and size companies have a greater sensitivity to short-term interest rates. The catalyst for the rate cut is more important for the stock and bond markets- i.e. are the rate cuts due to an impending recession?
- For example, small cap stocks use significantly greater floating rate financing compared to large cap stocks. Falling short-term interest rates are expected to boost small cap stock earnings. This is one reason why small cap stocks have outperformed large cap stocks in the US since June 30th.
- Bond investments will generally benefit from the interest rate cuts but like fixed mortgages, the exact impact is more nuanced. When prevailing interest rates fall, the value of existing bonds increases in value. The benefit for bond investments will be reduced if longer-term yields stay higher or increase, similar to what happened after the rate cuts in 2024.
Rate cuts bring both opportunities and challenges, and staying informed and proactive can help you navigate the shifts with confidence. Since every situation is unique, we’d be glad to review how these changes may affect your goals—let’s start the conversation.