The Fed Has Cut: Its First Step toward ‘Neutral’

By Dean Austin, CFA, CAIA,
Senior Investment Consultant, Synovus Trust Company

The Federal Reserve’s 50 basis point rate cut marks an aggressive beginning to its first easing campaign in four years, lowering the federal funds rate to 4.75% - 5.0%. This move aims to approach the "neutral rate," balancing inflation and economic growth. Despite solid economic indicators, this unexpected cut indicates a shift toward a less restrictive monetary policy due to signs of slowing growth and a weakening labor market. With inflation shrinking, the Fed seeks to support the economy and maintain employment levels, avoiding a potential downturn. Powell stated that this policy recalibration will take time, adjusting from last year's high inflation and low unemployment to the current economic conditions.

This sizable rate cut is uncommon and indicates that, while the Fed wants to preserve the current economic strength, it remains prudent. It aims to balance promoting growth with preventing long-term excessive inflation. The post-meeting statement read, “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”

This cut could also be a proactive measure to mitigate potential risks in global markets or domestic sectors like housing, which have been affected by higher borrowing costs. Consequently, some of the most noticeable benefits of this rate cut for everyday Americans will be in housing, auto loans and credit cards.

Initially, financial markets reacted positively with major equity indices rising due to lower rates, making borrowing cheaper and potentially boosting spending. However, in the last hour, investors took some profits. Rate-sensitive small caps remained positive, posting slight gains. The next day, markets surged to all-time highs, and the risk-on sentiment led to higher bond yields and a steeper yield curve.

Traditionally, stocks, bonds and alternative investments thrive during rate cuts, but with a possible additional 75 basis points in 2024 and another projected 125 basis points in 2025, cash will lose its "King" status. The $9 trillion in global money market assets will gradually shift to more profitable avenues, benefiting equities.

When rates fall without a recession, you might need to tweak portfolios. With stocks performing well and expected volatility during the Fed/Election period, we suggest balancing equities and fixed income due to high valuations. We prefer U.S. large caps over mid and small caps for their quality. This preference for quality also applies internationally — we favor domestic stocks and developed over emerging markets.

The credit cycle is robust, with solid fundamentals and technicals, particularly for quality core fixed income. With declining rates, consider extending duration by opting for longer maturities to secure yields. We favor managers with broad sector exposure, including securitized credit, high yield and emerging market debt. Securitized debt aligns well with our quality focus due to its strong fundamentals, yield premium and structural protections, making it an excellent diversifier.

Overall, this 50-basis point reduction showcases the Federal Reserve's adaptability to shifting economic scenarios while underscoring the fine line it must tread between fostering growth and controlling inflation expectations. Powell emphasized this by adding, “They will be making decisions meeting by meeting based on incoming data, the evolving outlook, and the balance of risks.”

Given the economic context, markets will scrutinize Powell’s statements to predict future policy directions and the general economic forecast.