Fed Cut, Now What?

by Jake Waldenmeyer, CFP?, AAMS?

Those of us in the financial services industry watched with great anticipation as to what the Fed’s next move would be on Wednesday when they decided what adjustment, if any, should be made to the target interest rate. In the end, sentiment shifted dramatically at the eleventh hour, and the decision was a cut of 50 basis points, or half a percent, to the Fed Funds rate, bringing the range to between 4.75-5.00%.

This type of decision may seem like something that only concerns massive institutions and the decision makers who run them, but we would stress that we believe that changes in rates can function as signals to the economy as to where the Fed believes we are in the economic cycle as well as indicators of what particular asset classes and segments of the economy may perform well moving forward.

Simply put? While we do not believe in timing the market, there is a lot of data to back up the idea that certain assets perform better than others during different stages of the economic cycle.

We’ll start with the obvious. Our industry professionals spent considerable time the past couple years encouraging investors to review where they keep their low-risk assets, which we will refer to as “cash”. Many had grown used to receiving little to no yield on their bank account balances and other short-term instruments during COVID as rate targets sat near zero for two years. Because of this, as rates increased, the spread one could make in being discerning on cash management became a very topical discussion for advisors looking to do right by their clients.

Now, the inverse is true. During a cutting cycle, these instruments that in many cases had been yielding north of 5% will incrementally decrease their yields as new issuance comes about. Over the next couple of years, the Fed Dot Plot (a collection of dots representing where each member believes rates are heading over the middle and longer term) shows the Fed Funds rate settling out longer term in the 2.5-3.0% range.

Thanks to compound interest calculators, we all know what even a 1-2% change in annual return can do over a decades-long time horizon to the outcome of our financial plan and the goals we wish to achieve as investors. Knowing that, in the face of losing a 5% “sure thing” in cash assets, where is an investor to go?

History indicates that the beginning of a cutting cycle means that not only cash assets, but fixed income across the risk spectrum will experience lower yields moving forward. We suggest considering areas of the market like private credit where unique opportunity sets and structures of deals will lessen the effect of these cuts. Additionally, yield differentials still favor private credit relative to public, giving us a positive outlook on the private credit space as a place to generate alpha in portfolios.

Another segment of the market poised to benefit from falling rates is real estate – particularly the net lease space. During a cutting environment, these net lease agreements may experience a surge in asset value due to the rates of the underlying holdings relative to their new issue counterparts, while contractual rent increases can provide a steady increase in yield while yields elsewhere are otherwise falling.

There are numerous other market segments that we believe are appealing in a declining rate environment that we won’t get into here, but as we’ve said before, access to markets beyond simply public equities and debt is becoming increasingly important to anyone wishing to preserve and grow their wealth.

We encourage investors to discuss with their financial advisor how these macroeconomic effects might impact their plans, and what changes are being made to shore up their goals and what they are trying to achieve.

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Disclosures and Disclaimers This blog posting is distributed for informational purposes only. The opinions expressed may contain certain forward-looking statements and should not be viewed as recommendations or personal investment advice nor should it be considered an offer to buy or sell specific securities. All information contained in this blog posting is obtained from what we believe to be reliable sources.

?Past performance is not an indication of future returns. Any legal, tax, and/or insurance related information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal, tax, or insurance advice. We do not provide legal, tax or insurance advice. Always consult an attorney, tax, or insurance professional regarding your specific situation.

Our statements and opinions are subject to change at any time without notice and should only be considered in the context of a diversified portfolio. Individual securities or markets mentioned in this article are not necessarily held in client portfolios and our opinions expressed about them should not be seen as a recommendation to buy, sell or hold any of them.

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