The Federal Reserve recently reversed course and cut interest rates. SMI executive editor Mark Biller explained why that's significant and what it may mean for investors yesterday on Moody Radio's MoneyWise Live.
To listen, click the play button below — or, if you prefer, scroll down for a transcript.
(For more radio appearances by members of the SMI team, visit our Resources page.)
MoneyWise Live, with hosts Rob West and Steve Moore, airs daily at 4:00 p.m. ET/3:00 CT.
To ask a question on a future program, call 1-800-525-7000 and mention you have a question for either Mark Biller or Matt Bell of Sound Mind Investing.
Steve Moore: Interest rate cycles can have a major impact on your finances, both good and bad, and we'll find out how today with investing expert Mark Biller — and we take your calls and questions at 800-525-7000. Your host is financial planner and teacher Rob West. I'm Steve Moore and we're breaking down the Fed's latest move right here today on MoneyWise Live.
Well, Rob is no one better to help us make sense of the recent interest rate drop than Mark Biller, executive editor at Sound Mind Investing.
Rob West: My thought exactly, Steve. Mark, welcome back to MoneyWise.
Mark Biller: Thanks, guys. Good to be here.
Rob West: First, explain just what the Federal Reserve is.
Mark Biller: Well, first of all, the Federal Reserve or the Fed is the central bank here in the United States — and they're really significant because they set the underlying short term interest rate that really all other interest rates are based off of. So at the end of July, this event that we're talking about, the Federal Reserve cut interest rates for the first time in over a decade. The last time they had cut rates was at the end of 2008, which of course was right in the teeth of the global financial crisis.
Rob West: Yeah. And this recent cut was a move the markets were expecting.
Mark Biller: Yeah, that's right. So the Fed had cut interest rates down to near zero way back in 2008, and then they left him there for years. Then a few years ago, they had started raising those rates very gradually, just a quarter-percent at a time. And over about three years they had raised them nine times, which put interest rates — that base interest rate again that we're talking about — in the 2½% range. But their last hike didn't go over well. If you remember, that was the hike — that was the immediate catalyst for making the stock market plunge last December. And that made the Fed really quickly backtrack, and they basically announced at that point that they were pausing that rate-hiking cycle.
Then in May, the economic reports started showing signs of weakness and the stock market fell about 6% that month. That prompted the Fed to start talking openly about starting to cut rates again. So this move that happened at the end of July was the first actual cut that they've made, but the market had been anticipating that cut for a couple months already.
Rob West: Let's talk for a moment just about some basic economics here. Why is it that the market always tends to react positively to rate cuts, negatively to rate hikes — and how does inflation play into all of that? Give us a sense of what's going on here that makes the market react one way or the other.
Mark Biller: Sure. Well there are a few different things in there. But one that's pretty significant is to some degree bonds do compete with stocks for investor dollars. So as rates go down, that tends to make bonds less attractive over the long-term as competition for stocks. So that helps stocks out. But also, you know, there's a fundamental interplay between interest rates and the economy. So as interest rates come down, that's kind of pushing on the accelerator of the economy. That's what the Fed is trying to do. When they see economic weakness, they'll cut rates to try to give a boost to the economy.
Well, of course, anything that's boosting the economy is good for stocks and the companies behind those stocks as well. On the flip side of that, when the Fed is hiking interest rates, that's when they see the economy usually starting to run a little hot and they're getting nervous about inflation. So they'll raise those interest rates as kind of hitting, tapping the brakes on the economy. Well, of course, the stock market doesn't like that very much. So stocks tend to fall when that happens.
Rob West: Is this latest cut a sign that the Fed is worried about a recession in your view?
Mark Biller: Yeah, I would call it a very early warning sign. I think that, Rob, as you look around the world, there are basically two economies out there right now: You've got the U.S. and then you've got everyone else. You know, the U.S. economy is still is doing pretty well, but the rest of the world is flashing some pretty serious signs of a possible impending recession. And with so much of our own economy tied to the health of our trading partners and our global customers around the world, it's really hard to imagine that the rest of the globe could slip into a recession without it eventually dragging the U.S. into one as well.
And I think that the Fed sees that as well, and so they're making this move. You know, this cut does provide a little bit of direct help. But probably just as important, it also sends a signal that the Fed does recognize that the effort of the last three to four years to kind of normalize interest rates from those historic lows, that that's basically over. We're done with that cycle, and the new effort of trying to delay the next recession through these rate cuts is officially on.
Rob West: Let's talk about how this intersects with Main Street, Mark. How should our listeners expect these lower interest rates to impact them?
Mark Biller: You kind of have to divide this into — you've got the impact on savers and the impact on investors. And first of all, for savers, unfortunately, falling interest rates really hurt savers. And if you've been a saver over the last 10 years, you know what I'm talking about, because a lot of savings vehicles really hadn't even boosted their interest they were already paying very much from those near-zero levels that we've seen for so long.
Now, if you were one of those proactive few people who had shifted your savings to an account that was paying a little bit better interest in a money-market account or a better bank account, unfortunately with these cuts, the rate that you're getting now is likely to go down. Might not happen immediately with this first cut, but certainly if the Fed follows through with more interest rate cuts, banks are going to quickly follow suit. Unfortunately, banks are really slow to raise interest rates, but they're very quick to cut them down.
Steve Moore: Mark, what we've been talking about today so far, I'm wondering how this impacts our average listener right now, who might be saying, "Great — so what do I do? What changes do I make?" And do we allow these recent headlines encourage us to make some changes? Or do we just stay put?
Mark Biller: Yeah, for most people, this probably is not a big take action kind of event because when you really boil it down, falling interest rates are good for borrowers and are bad for savers. We just explained why they're bad for savers, but it's not as if there's some great alternative to go jump into with your savings. Typically, you're in savings because you need something safe and something liquid. And that's true even if the interest rate is ticking down little by little.
Now for borrowers, this is great news. But hopefully most of our listeners are on the path of getting out of debt, not accumulating more debt so they're not going to get a big benefit from that unless they happen to have a higher-interest mortgage and as rates come down, you know, you might have the opportunity to refinance at a lower rate. Other than that, there probably isn't big "take action" kind of element to this news today.
Rob West: Mark, let's talk about the other group that's impacted by this rate cut — and that is investors. How should they expect to see this impact them?
Mark Biller: Yeah, well in the short term, falling rates are definitely good for bond investors because Bond Investing 101 is that as interest rates fall, bond prices go up. And in fact we can see that the bond market has been anticipating these cuts all year really, since they started talking way back in December about pausing the hiking cycle. So we've seen bonds already putting in a great year. 2019 has been great for bond investors as interest rates have been coming down on the bonds — the interest rates that the Fed doesn't control directly — those have been anticipating these cuts and giving bond investors really good returns.
Now, it gets a little trickier for stock investors as we talked about a little bit before. Stock investors love lower interest rates and always cheer right away when you get a rate cut. But if the reason that interest rates are getting cut is because the economy is at greater risk, you know at some point there's a tipping point where the fear of recession can kind of outweigh the benefit of these lower rates.
Sometimes investors don't get worried about that soon enough and it kind of hits them and blindsides them when a recession arrives and smacks stock prices around pretty good. But generally speaking, stock investors tend to always think the recession is way off in the future and I'm not going to worry about that. And to be fair, usually when the Fed starts cutting rates, you usually do see several more months, at least, of good stock returns.
Rob West: Yeah,.
Mark Biller: I would just add to that, Rob, that you can't really count on that. And the example I give of that is really the last time that the Fed shifted from hiking rates to cutting rates was September of 2007. If you go back and look at that, that first cut, the economy seemed to be in pretty good shape then, too. But the stock market actually put in its bull market peak just three weeks after that cut. Now, it didn't fall over and fall apart right away. It took a while for that bear market to gather steam. But we were pretty much done going up at that point. And, you know, a year later we were in the thick of that global financial crisis. So you can take these patterns with a grain of salt. Usually you don't have a lot to worry about right away with a first cut. But again, you can't really bank on that.
Rob West: Mark, if the economy is cooling and this is the beginning of a series of rate cuts, should that change your allocation to stocks and bonds as a long-term investor, or do you just stay the course?
Mark Biller: Well, I think that for a long-term investor, you're going to want to follow your plan and stay the course. Now, hopefully your plan already accounts for the fact that we've had a long bull market. Stocks are priced very richly by historical standards. We have to recognize the cyclical nature of the market and that we're really due for a bear market at some point. And these are warning signs. You know, from what we're seeing that that's probably not really far off in the future. So we should be conservatively positioned, but it's not something we need to panic over as long as you've got a long time horizon.
Steve Moore: Yeah, good point from our guest today, Mark Biller from SoundMindInvesting.org. We don't panic. We make long-term plans. We ask God for his wisdom. Remembering that we put our trust in him and in him first. Mark, thanks for joining us. God bless you, sir.
Mark Biller: Thanks, guys.
Rob West: Thanks, Mark. Appreciate your being here.