When the Federal Reserve lowers its key short-term interest rate—the federal funds rate—financial markets often move in response. But the impact isn't uniform across the board.
How could a Fed rate cut affect your balance sheet?
Here we look at what has happened historically to various parts of the market.
Short term
Cash investments—negative impact
Yields on cash investments typically fall, but the impact on various cash-related investments can vary.
Certificates of deposit (CDs)—negative impact
CD rates often fall, but not necessarily by the same amount across all CDs of all maturities.
Savings accounts—negative impact
Bank savings rates generally have fallen gradually.
Stock market—uncertain impact
Although stock markets initially may welcome a rate cut as a counterbalance to slowing economic growth, if the slowdown turns into a recession, markets tend to decline after an initial rate cut.
Financial stocks—negative impact
A shrinking gap between what banks pay on deposits and charge on loans can hurt bank stocks.
Utilities stock—positive impact
Because they typically pay steady dividends, utilities stocks tend to outperform as investors shift away from lower-yielding fixed income investments.
Adjustable-rate mortgages (ARMs)—positive impact
Usually tied to short-term rates, ARM rates can be expected to fall.
Auto loans—positive impact
Often tied to short-term rates, auto loan rates may fall. However, rates can vary depending on sales incentives and other factors.
Home equity loans—positive impact
Rates on home equity loans usually track short-term interest rates and may move gradually lower.
Short-term bonds—uncertain impact
Initially, short-term bond prices may rise. However, as existing bonds mature and their proceeds are reinvested into new, lower-yielding securities, the income they generate declines over time.
Intermediate term
Intermediate-term bonds—uncertain impact
Intermediate-term bonds are usually more sensitive to interest rate changes, so their price gains may be greater than for bonds with shorter maturities.
Asset-based loans—uncertain impact
Rates on loans such as pledged asset lines and margin loans may fall gradually.
Federal student loans—uncertain impact
The annual rate on federal student loans is based on the Treasury Department's auction of 10-year notes in early May, and 10-year yields are influenced more by growth and inflation expectations than by changes in the federal funds rate.
Global stocks—positive impact
International stocks generally have outperformed U.S. stocks during rate-cut cycles.
Long term
Long-term bonds—uncertain impact
While longer-term bond prices may initially rise, over time they are more affected by growth and inflation expectations than by the federal funds rate.
Mortgage rates—uncertain impact
Fixed mortgage rates generally track 10-year Treasury yields, so a lower federal funds rate won't necessarily drive mortgage rates lower.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Investing involves risk, including loss of principal.
The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.
Past performance is no guarantee of future results.
Supporting documentation for any claims or statistical information is available upon request.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Cash equivalent investments are cash management strategies that seek to prevent the loss of an investment's total value. Although a cash management product may seek to maintain a stable or constant net asset value, there can be no assurance it will do so.
There are risks associated with investing in dividend paying stocks, including but not limited to the risk that stocks may reduce or stop paying dividends.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
0824-J3LA
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our videos.
© Charles Schwab
Read more commentaries by Charles Schwab