The Power of Rate Cuts

A fair amount of recent financial news has not been supportive of stocks.  Consumer confidence is down, inflation is still well above target, and the labor market is softening.  As J.P. Morgan’s Dr. David Kelly said recently, the US economy is slowing, ever so slowly.  Add to that a partial shutdown of the U.S. government, and you would not think the market would be at or near record highs.

But despite the challenging data, there’s an adage in investing circles that is at play: “Don’t fight the Fed.”  Stocks are where they are, in large part, because investors believe an interest rate-cutting trend is underway.  And as we know stocks (and bonds) love lower interest rates. 

One would think putting 750,000 government workers on furlough (about a third of the civilian federal workforce) and shutting many services would hurt the stock market.  But for short government shutdowns, the stock market has historically remained resilient, often recovering quickly or continuing its existing trend.  The typical shutdown lasts only about 8 days, with the longest being 35 days and 2018/2019.

Most investment analysts agree that shutdowns are more political theater than economic fundamentals.  For longer-term investors, the focus should remain on core drivers like corporate earnings and overall economic growth, rather than short-term political headlines.  Historically, the market has tended to rally in the 12 months after a shutdown ends, rewarding investors who stayed in the market.

When you hear “don’t fight the Fed,” it means that it’s generally a bad idea to go against what the Federal Reserve is trying to do with the economy.  The Fed controls interest rates and money supply to keep inflation low and employment strong.  If they are raising interest rates to slow down inflation, and investors don’t pay attention to the tighter monetary policy, they’re likely to lose money.  That’s because higher interest rates make borrowing more expensive, slow down spending, and reduce profits.  Trying to bet against that trend is like swimming upstream, it’s exhausting and rarely works.  The reverse is also true.  When the Fed lowers its interest rate, it tries to boost growth and support employment, which typically supports stock prices. 

If you ignore these signals, whether you’re investing, running a business, or just trying to make smart financial choices, you could end up making decisions that don’t match the reality of the economy.  Paying attention to the Fed helps you stay in sync with the bigger picture and avoid costly mistakes.  So “don’t fight the Fed” is really a reminder to respect the power of economic policy and make choices that go with the flow, not against it. 

If the Fed is supporting the economy by lower interest rates, it usually helps stocks and other investments.