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In the U.S., inflation has broken beneath the 3% barrier for the first time in four years, posting an increase of 2.5% in August. Over the last two years, the Federal Reserve has been on a quest to contain inflation by tightening financial conditions. In September, the Fed eased monetary policy by lowering the federal funds rate. Other central banks are adjusting monetary policy as well, but not for the same reasons. How will the new wave of global interest rate adjustments affect your portfolio?
The Federal Reserve raised the federal funds rate 11 times since it first began raising rates in March 2022. On Sept.19, the Federal Open Market Committee announced a rate reduction of 0.5% to the federal funds to bring the key rate down to a range of 4.75%-5%.
The Fed directly influences the federal funds rate, while other rates are set by investors. The federal funds rate is the overnight rate that banks charge each other for short-term loans to maintain reserve requirements. For example, a bank with excess reserves can lend those reserves to another bank that might fall short of meeting reserve requirements after end of day transactions settle.
The Federal Reserve has two mandates from Congress: maximum employment and price stability. With the most recent inflation reading at 2.5%, and the Bureau of Labor Statistics reporting the unemployment rate at 4.2% in August, it appears the Fed is on its way toward meeting those two mandates and, perhaps, helping the U.S. economy circumvent a recession.
Other central banks around the world are also adjusting monetary policy. China, Mexico, Canada, all of Europe, South Africa and other regions have dropped their key interest rates. However, the central banks of Japan, Brazil, Nigeria and Russia, for example, have raised key interest rates.
China, for example, cut its key interest rate recently. However, unlike the Fed rate cut, this cut is not a victory over inflation, but an attempt to stimulate a stagnant economy. China’s GDP growth has been hovering between 0.5% and 1.5% for the last five quarters, according to Trading Economics, with the most recent quarter posting a rate of just 0.7%. The People’s Bank of China has undertaken a variety of other stimulative measures in addition to lowering its key interest rate.
Mexico also cut its key interest rate from 11% to 10.75% in August, citing the expectation for a slower economy ahead and higher inflation moving forward. However, inflation in Mexico has been trending up. Typically, central banks raise rates to cool inflation. Reuters reports this contradictory tactic to cut rates when inflation is rising has left many analysts perplexed.
Brazil raised its key rate from 10.5% to 10.75%. The Brazilian policy committee is anticipating a rise in inflation partly due to droughts and the risk of fires that would make goods scarcer, newspaper Brasil de Fato reports, which would drive prices higher.
After 17 years, the Bank of Japan raised their key interest rate for a second time. The first hike in March led it out of negative territory. The latest increase in July raised the key rate from 0% to 0.25%. Japan’s negative interest rate policy meant that the BOJ was charging banks for having excess funds on deposit instead of lending the funds out to stimulate the economy. Japan’s latest inflation reading in August came in at a healthy 3%, a stark contrast to the deflationary environment they’ve been fighting for the better part of two decades. However, Japan’s GDP has bobbed on either side of 0% for years, according to Trading Economics. This slight increase in the key interest rate is an attempt to contain inflation without sacrificing growth.
Back in the U.S., the much-anticipated rate cut in September has continued to lift stocks to new all-time highs and put downward pressure on interest rates across the spectrum. As an example, 12 months ago, the national average mortgage rate was 8%. Today, the national average rate on a 30-year mortgage is right around 6.25%. Twelve months ago, the S&P 500 was trading around 4,300. Today, the S&P 500 has crossed 5,700.
Additionally, in June, the Fed began to allow $25 billion in Treasuries to run off the balance sheet compared to the $60 billion it had been doing up until then. This effectively leaves an extra $35 billion per month in the economy. More money in the economy coupled with a reduction in rates could lead to a strong economy ahead.
Check in with your portfolio manager to review how your portfolio has stood up against elevated inflation and make sure it’s positioned for the new wave of global monetary policy.
Andy Drennen is a certified financial planner and senior portfolio manager at Simmons Private Wealth in Springfield. He can be reached at andy.drennen@simmonsbank.com.
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