Interest Rate Impact

A lower interest rate doesn’t make debt go away. ~ Dave Ramsey

Question: How do lower interest rates influence economic conditions and impact my financial plan?

Answer: Interest rates have a great deal to do with the U.S. economy since growth is in part driven by lending. Lower interest rates have far-reaching effects that include these areas:

Retail credit: Interest rates on new loans are likely to come down, including rates on mortgages, auto loans, securities-based lending, and home equity loans. Interest rates on existing variable rate loans, such as adjustable-rate mortgages (ARMs) and credit cards, may also decrease.

For those who took on a new traditional loan while rates were higher, it probably won’t be worth the cost in fees to refinance, at least not yet, but the current consensus is that the Federal Reserve will continue lowering rates. However, don’t expect those near-zero interest rates of the early 2010s or 2020/2021 to return. They were a historical anomaly while the Fed was addressing the pandemic slow down. The Fed felt the need to increase the money supply and keep the cost of money low (interest rates) while the economy was shut down. The result was inflation, and higher rates with it now appearing to be the time to begin lowering those rates.

Stocks: Lower interest rates help support economic activity, so it follows that we’d expect stock prices to increase. However, the market is forward looking with a keen eye on the future. Since this recent rate cut was /anticipated for a long time, the potential gains from it may already be baked into current stock pricing.

Lower interest rates are expected to help areas of the stock market bounce back from challenging conditions. For instance, small- and medium-sized (SMIDs) companies generally benefit more from lower interest rates and less expensive borrowing costs than do larger companies. In the recent past, SMIDs were at a disadvantage and challenged when compared to mega-size large capitalization companies regarding borrowing costs.

Bonds: As overall interest rates in the consumer retail and commercial credit markets decline, bond yields will likely also go down. This decrease may already be priced into the forward-looking markets. Lower interest rate costs are a plus to institutional borrowers, but also to those who purchased bonds when yields were higher. The value of a bond typically increases when rates decline. There is an inverse relationship between yields and bond prices. The value of those higher-yielding assets on the secondary market goes up as yields on newly issued bonds go down.

The Economy In the post-pandemic world, the U.S. economy is unequaled in its resilience. However, by the middle of this year, economic data started slowing down. This caused the inflation rate to continue decreasing after a first-quarter hiccup giving Fed leaders permission to lower interest rates. By lowering interest rates now, the Federal Reserve is saying it’s confident inflation will continue to subside, and they’ll attempt to cushion the slowdown in economic activity. This is meant to counterbalance effects from slower job creation, slower wage growth and a loss in consumer confidence.

As time goes on, we’ll see how the balance of these forces plays out; it’s a delicate dance. Despite the boost from lower interest rates, it’s likely the economy will continue to slow down, as monetary policy works with long and variable lags. A period of shrinking economic output, otherwise known as a recession, seems like only a narrow possibility.

Adjusting to new conditions Changes in inflation and interest rates can alter decisions and the math behind paying off debt at higher interest rates. Interest rates and inflation can also change the risk profiles of different types of investments. If it’s been some time since you’ve reviewed your portfolio, risk appetite and comfort zone it may be time to have a look at these factors.

Changes in the external investment environment suggest that it’s time for a review with your CERTIFIED FINANCIAL PLANNER® Professional. This is an opportunity to evaluate your personal financial plan and determine if you have either too much or too little risk in your portfolio. Every investor’s situation is unique, and you should consider your individual investment goals as they pertain to debt, risk, and retirement timing. Stay focused and plan accordingly.

The opinions expressed are those of the writer as of September 26, 2024, but not necessarily those of Raymond James & Associates, and subject to change at any time based on market conditions and other factors. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and investors may incur a profit or a loss. Every investor's situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Raymond James Financial Services, Inc. does not provide advice on mortgages.

Certified Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements. This article provided by Darcie Guerin, CFP®, First Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at (239)389-1041, email darcie.guerin@raymondjames.com Website: www.raymondjames.com/Darcie