With the Federal Reserve likely to cut interest rates this year, investors remain unfazed. That’s because interest rate cuts bode well for stock investments. Investors typically enjoy stronger returns in low-interest rate environments because of consumer and business spending rise.
However, as markets closed June 21 within record highs, more information was revealed as to what Fed members are evaluating in determining what should happen with rates. Instead of focusing on what stocks to buy or sell right now, make sure you understand why the Fed is considering lowering them in the first place.
Understanding how the Federal Reserve impacts the market as a whole and individual industries is crucial if you’ re looking to get a job on wall street. Here, we’ll go over some of the macroeconomics the Federal Reserve is considering as it determines whether to cut, or even raise rates.
Fed Leaves Rates Unchanged as it Sits in Brief Wait-and-See Mode
On June 19, Fed Chair Jerome Powell announced that the bank would not move to cut rates this year. Instead, the central bank will hold off on cutting rates until next year, and then only one or two may happen, Powell indicated.
One of the reasons rates were held steady was to allow members to gather more information about the economy. Also, the Fed is likely waiting to see what will come of President Trump’s meeting with Chinese President Xi Jinping at the G-20 summit this month in Japan. The looming trade war between the two countries has the attention of everyone, including the Federal Reserve.
Any worries that the economy was heading into a recession are aggravated by the negative effects of a trade war. If the U.S. fails to reach an agreement with China, the cost of consumer goods will be impactful. Considering it is the consumer that has held up the booming economy, anything that affects their spending habits will be detrimental. To lessen that sting, the Fed will have even more reason to lower interest rates, not raise them.
What Powell said for Investors to Cheer and Frown About
Investors, while not surprised, welcomed news from Powell that the labor market “remains strong” and the economy continues to expand at a “moderate” pace.
Again, concerns remain over the effects of the U.S.’s tariffs on China. The first round is already having a negative effect on companies that export to the country. They are also adversely hurting U.S. farmers.
In May, the Trump administration more than doubled tariffs on roughly $200 billion of Chinese imports. It threatens to hit another $300 billion of goods if a trade deal is not reached. As far as the labor market is concerned, the fact that hiring slowed significantly in May cannot be ignored.
Market still Braces for a Cut Sooner and Here’s Why
Clearly, getting a hold of the state of the economy based on Fed speak is a chore. Market observers are choosing to brace for a rate cut. For many, especially those who think the Fed is engaging in a game of kick the can down the road, a cut is in order.
In fact, the interest rate futures markets showed a 100% probability of a July rate cut as of Friday. The question is, “how much that rate cut will be?” with many looking for it to be 25 basis points.
Market observers quickly pointed out that Powell’s statement didn’t include the word “patient.” Previously, that word annoyed the market because it was one of uncertainty. With that word being gone, most see it as meaning the Fed is ready to cut rates, instead of just waiting for the worst to happen, such as the country headed for the brink of a recession.
Fed Members Disagree Sharply, but Investors should Hone in on their Dissents
Two days following Powell’s statement, members of the Fed began speaking out, with some even saying that a rate hike was in order. There are significant differences in opinions among the members as to the state of the economy.
Reportedly, about half of Fed members don’t see any rate cut happening this year, while the others see a cut of up to a half of a percentage point.
For example, Fed vice chairman Richard Clarida told Bloomberg there was “broad agreement” that a rate hike was in order. However, Minneapolis Federal Reserve bank president Neel Kashkari believes rates should be cut.
The belief that a cut is happening relates to inflation. This was the sticking point among Fed members based on the comments many of them made following Powell’s announcement that rates will be held steady.
The Fed has an inflation target in place that voting members use to determine whether interest rates should move higher or lower. Some members still see price increases as not moving strong enough, which makes for a rate cut being in order.
Managing Portfolios in Uncertain Environments
Investors must not only contend with the split in opinions about the economy among Fed members. They must also deal with a series of news events that can cause the markets to move. There is a constant headline risk that must not be taken lightly. Look no further than this week with the increased aggression from the Iranians against the U.S.
During this recent spate of non-positive news, the markets still showed impressive resiliency. In fact, the Dow, S&P 500 and Nasdaq all approached record highs. Investors are unnerved.
A defensive play to consider is to invest in the consumer staples sector.
What Happens Next?
The Federal Reserve is set to meet again at the end of July. By this time, the belief is that they would have sorted out their thoughts about the economy. More economic numbers will be in to show if the Fed’s 2% inflation target has been hit, is on pace to be hit, or is not in reasonable reach.
Also, it is hoped that by then, more clarity, or even an agreement, will be in place between China and the U.S. over tariffs. June job numbers will be in to give more of an indication that the labor market remains strong.
One thing is for sure, no matter what the Fed decides to do with interest rates next month, it will be some time before investors really start to see the effects. That’s because it typically takes about a year before the economy feels the effects via higher borrowing costs if there is a hike, or vice versa.
As far as your portfolio is concerned, continue to seek investments that maintain your returns during uncertain markets.
About the Author
Todd Massedge is the founder of Tier 1 Wall Street & the Invest Like The Street Analyst Program, whose goal is to help people succeed in landing some of the best jobs on Wall Street. He started his career by working in healthcare-related credit, before moving on to the hedge fund space where he focused primarily on cover chemical companies and now runs the Alpha Tree Group.
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