What investors should know about dropping interest rates

Tyler Kert
Tamarack Wealth Management

On Wednesday, September 18, the Federal Reserve announced a pivotal decision to reduce interest rates by 50 basis points, or ½ of a percent. This move comes after rates had reached their highest level in 23 years, as the Fed sought to manage inflation and ensure stable economic growth. As investors figure out how to react to this rate cut, it's important to understand how this shift will impact various asset classes and the broader financial markets. The goal of lower rates is typically to encourage and stimulate economic activity, but the actual implications for stocks, bonds, real estate, and other investments can vary. Here’s what you can expect as these changes take effect.

Stock Market Impact: Potential for Growth

Lower interest rates generally help the environment needed for the growth of stocks. Lower interest rates mean lower borrowing costs. With borrowing costs reduced, companies can finance growth and expansion more cheaply, potentially boosting profits. Additionally, consumers will benefit from lower interest rates on auto loans and home mortgages which will increase their disposable income. More disposable income increases spending, which benefits businesses. Sectors like technology, real estate, and utilities—where companies tend to carry more debt—often see gains as their borrowing costs decrease. However, you should always remain wary of speculative bubbles, especially in growth stocks that rely on cheap borrowing to fuel expansion.

Bond Market: Lower Yields, Higher Prices

Interest rates and bond prices have an inverse relationship. As rates fall, existing bonds with higher yields become more attractive, driving up their prices. However, new bonds will offer lower yields, which can be less appealing to income-focused investors. If you are currently holding bonds, you can benefit from rising prices, but those seeking to buy bonds after the rate reduction will likely face lower returns. Long-term bonds often see the biggest price increases, but they also carry more risk if inflation unexpectedly accelerates.

What is the takeaway? If rates continue to decrease, long-term bonds will increase in value because they are still paying the higher yields. In other words, in a decreasing rate environment, the bonds you buy today will pay more than bonds tomorrow so don’t delay in implementing that strategy. 

Real Estate: Cheaper Financing, Rising Demand

Lower interest rates lead to lower mortgage rates, increasing demand in the housing market. If you are a real estate investor, you’ll probably find it easier to secure financing for properties, and the reduced cost of borrowing can improve returns overall. However, increased demand can also drive up property prices, making it more difficult to find affordable investment opportunities. Falling interest rates typically boost the real estate market, providing investors with enhanced access to capital. But you must weigh this against rising property prices and competition, which could limit the availability of affordable investment opportunities.

Inflation: High Yield Savings Accounts at Risk

One of the main reasons the Fed resorts to raising interest rates is to curb inflation. Now that they have lowered rates for the first time in 23 years, they are basically saying that they think inflation is under control. That is good news. But lowering rates will have a direct impact on the high yield savings accounts and money market funds that have exploded in popularity in recent years. Don’t be surprised to see these rates come down rather quickly from the 5% returns in some cases. 

Investors that are looking to outpace inflation will need to adjust their strategies to incorporate more of the investments that were discussed in the beginning of this article. Stocks, bonds, and real estate have a history of outpacing inflation and generating positive returns over the long term. Money Market funds and CDs are much more hard pressed to generate the returns needed to outpace inflation over time. Essentially, you can never avoid risk altogether. Either you face the risk of investing in the market, or you keep your money in cash and face the risk of inflation reducing your purchasing power. 

Conclusion

As the Federal Reserve moves to reduce interest rates, investors should take these changes into account as they monitor their financial plan. While lower rates generally provide a boost for equities, bonds, and real estate, they can also introduce the risk of inflation. A diversified investment strategy and careful monitoring of market conditions will be key to navigating these changes effectively. Don’t forget to take taxes into account too. At the end of the day, it’s not what you make that matters, it’s what you keep.

Tyler Kert, a licensed financial advisor and CPA, provides financial planning and tax consulting services at Tamarack Wealth Management in Cashmere, WA.