How Fed rate cuts can impact your portfolio—and how to make the most of them

Fed Chair Powell

Why Fed rate cuts are important to investors

The Federal Reserve, or the Fed, manages interest rates to manage economic growth and inflation. Lowering the rate tends to make loans cheaper, encouraging spending and investing. For investors, these forces pass through financial markets, influencing everything from the price of stocks to the return on bonds. Understanding how these forces work can help you rebalance your portfolio to protect your riches and take advantage of opportunity.

Impact on equities

Rate cuts are bullish for stocks. Decreased borrowing costs lower firm costs, boost earnings, and spur growth. At the same time, declining rates downvalue bonds, redirecting funds into stocks. Growth sectors such as technology, real estate, and consumer discretionary are likely to thrive under such an environment. But beware—rate cuts historically are done when the economy is slowing down, which may further weigh on firm earnings in the short term.

Bond market swings

With bonds, declining rates are a double whammy. Higher-coupon maturities appreciate because future issues will have lower yields, so the older ones are more attractive. But reinvestment risk is increased because future fixed-income purchases will have lower yields. Investors will benefit by holding longer-term bonds or bond funds that appreciate when rates fall and search for inflation expectations that can neutralize real return.

Real estate and commodities

Real estate is the other asset class that tends to benefit from falling interest rates. Falling mortgages make homes more affordable, and demand for houses and real estate investment trusts (REITs) are also boosted. Commodities, and gold in specific, also receive a lift as investors look to hedge the devaluation of currency caused by falling rates. Oil and industrial metals, however, may see accelerating demand if the general economy picks up pace after rate reductions.

Currency and International influence

Rate reductions make the U.S. dollar weaker due to the fact that reduced yields reduce foreign investors' appetite for dollar-denominated paper. The trend can benefit emerging market equities and dollar-denominated commodities globally. To foreign investors, a declining dollar can be a chance in foreign markets but subject currency-sensitive sectors to foreign exchange capriciousness.

How to position your portfolio

To benefit from Fed rate cuts, remain overweight in growth industry stocks, boost exposure to long-term bonds, and selectively invest in REITs or commodities. Diversification is still important, remember—rate cuts indicate the economy is struggling, so diversifying risk between assets will shield you from overexposure to one result. Maintaining constant vigilance of Fed announcements and economic reports will help you be prepared for surprise policy shifts.

FAQs

Q1: Are rate cuts by the Fed always good for the stock market?

Not always. Although falling rates generally are a stock blessing, they are usually followed by slowdowns in the economy that reduce business profits.

Q2: Do I purchase more bonds when the Fed reduces the rate?

Bonds will rise in value, but newly issued bonds will receive less. Having a spread of maturities on bonds reduces the reinvestment risk.

Q3: How will day traders overseas be affected by rate cuts?

Rate cuts make the dollar cheaper, likely to support emerging market and global commodities. Rate cuts do introduce volatility in global currencies, however.