Investment Considerations for Upcoming Rate Reductions in 2024
After holding rates steady since July 2023, the Federal Reserve maintained the overnight rate level at the December 2023 meeting and indicated that three rate cuts, each of 0.25%, are likely in 2024. This was in stark contrast to earlier statements that indicated the Fed intended to hold rates stable well into 2024 and even into 2025. As a result, interest rates have decreased, with the 30-year mortgage rate currently under 7% and the 10-year Treasury yield below 4% after hitting 5% in late October. This change in the Fed’s policy provides investment opportunities for stakeholders.
Background
The Federal Reserve Bank began hiking the overnight rate, the rate at which banks can borrow funds from other banks, in March 2022 in response to rapidly rising inflation. Before the March hike, the overnight rate was 0 to 0.25%. Over the following 11 meetings spanning 16 months, the Fed moved the overnight rate to a range of 5.25% to 5.50%, the highest level since 2001. The increased overnight rate pushed overall interest rates higher, with 30–year mortgages surging from around 3% at the start of 2022 to around 8% in November 2023. Higher overall interest rates helped push down inflation as some segments of the US economy slowed.
Investment Considerations When Rate Reductions are Pending
Lock in Interest Rates
Investors may want to lock in interest rates before they move much lower. This is particularly true for longer-term bonds. Currently, short-term yields remain above 5%, but when the Fed begins cutting rates, short-term yields will move down with the overnight rate. For example, the 1-year Treasury Bill is yielding about 4.9%, but when the bond matures, if rates have fallen, the funds will be reinvested at less attractive levels. However, the yields on Treasury Bonds maturing in five years or more range from 4% to 4.4%. It may be advantageous to lock in the current yields rather than purchase shorter-term higher-yielding bonds as reinvestment rate risk is rising.
Look at International Investments
The US dollar is up over 13% versus a basket of six major country currencies over the last three years. Higher interest rates in the US relative to most other developed market countries have contributed to the dollar’s gain. Therefore, international returns have been muted as the rising dollar has reduced returns for US investors. As the Fed has shifted the outlook from higher rates for an extended period of time to rate cuts in 2024, the US dollar has weakened. In the last month, the dollar is down 2.6%, which has boosted international equity returns. After several years of appreciation, the dollar is facing downward pressure as rate cuts evolve. International stocks, both developed and emerging markets, should benefit if the dollar continues to move lower.
Consider Small Cap Stocks
Large cap US stocks handily outperformed small cap stocks during the rising interest rate period. Since the first hike on March 17, 2022, the S&P 500 is up 9.8%, while the Russell 2000 Index (small cap stocks) is down 3.3%. Large cap stocks were viewed as better equipped to handle higher interest rates and slower domestic growth. Recently, small cap stocks have surged, with the small cap index up 14.3% in the last month versus 6.9% for the S&P 500. Small cap stocks typically outperform when interest rates fall and recession risks decline. The “soft landing” outlook for the US economy is increasingly likely and should be supportive of small cap stocks.
With rate changes potentially just around the corner, now is the time to talk with an advisor who is focused on your financial needs and goals, while also developing a sound strategy that will enable you to realize your dreams.
Meet the expert
Darin joined the Portland wealth management firm in 2004, bringing more than a decade of investment and financial consulting experience with him. As chief investment officer for Aldrich Wealth, Darin is responsible for developing, and implementing our investment philosophy and leading the investment committee. He works directly with some of our most complex and largest clients and also…
Darin's EXPERTISE
- Series 7 and 63 security exams
- Chartered Financial Analyst (CFA®)