September 2024

When the U.S Federal Reserve makes a decision about interest rates, the rest of the world watches closely. U.S interest rates, unti this week, sat at a 23-year high of 5.5% and had remained steady since the previous rate increase in July 2023. With inflation dropping markedly in the past few months, policymakers have made it clear that the time has come to start rate cutting, and did just that at the time of finalising this content with the Fed cutting rates by 50bp this week.

What Will Be Impacted?

The Fed was expected to cut rates by 25 basis points at their latest meeting but instead went further with a 50bp cut. Further, The Fed is expected to continue cutting at several of the remaining policy meetings through to 2025. The objective of a rate cut is to stabilise prices and stimulate economic growth. The following are some of the things that can occur not just in the US, but globally, based on a global rate-cutting cycle among all Reserve Banks:

• Repayments for those with adjustable-rate mortgages will decrease
• The housing market will receive a boost with homebuyers/builders having better access to capital
• Credit card debt will cost slightly less
• Motor vehicle loans and personal loans typically follow the path of the Federal rate resulting in a decrease in monthly repayments
• Stocks tend to do well after interest rate cuts as borrowing becomes cheaper for businesses and consumers which in theory is constructive for equities

Who Will Follow Suit?

A rate cut from the U.S Federal Reserve will encourage central banks worldwide to decrease their rates. The European Central Bank is expected to cut interest rates at their next opportunity but experts predict that the ECB will tiptoe rather than slash its rates. Some have already decreased rates slightly including central banks in Switzerland, Canada and New Zealand but the Reserve Bank of Australia has stood firm at 4.35% since September last year.

One of the reasons why other central banks follow suit is their exposure to the US market, for example, Australia. The US market, on the back of the ‘Magnificent Seven’, has outperformed the ASX for several years and this has resulted in many Australians increasing their exposure to the US market over the last 12-18 months. A surging Australian dollar will subsequently decrease inflation and build a stronger case for the Reserve Bank to cut rates.

How To Prepare For It?

A single rate cut may not make a significant difference but 2-3 consecutive cuts can completely change the long term economic landscape. With that in mind, here are some strategic decisions that should be considered, although of course we aren’t in a position to offer you financial advice…

Savings: Review and money held in savings accounts and term deposits. Check minimum balance requirements, consider locking in a fixed rate for a longer period, research high-yield savings options or diversify your savings.

Timing: Track your finances and watch out for the right time to refinance. The same applies to locking in long-term rates on cash deposits and entering/exiting investment opportunities.

An effective way to deal with changes in Fed or Reserve Bank policy is to have a diversified portfolio with a laddered approach. This strategy involves having investments spread evenly across a desired time frame and allows for the shifting of investments into the most suitable asset class at any given time.

In summary, the Fed rate-cutting cycle that started this past week is a great signal. This indicates the scourge of high-inflation is behind us and better economy times are on the horizon!