By John McDonald
On June 19, 2019, the United States Federal Reserve Board of Governors released a policy statement based on the recent meeting of the Federal Open Market Committee. Market reaction was swift and substantial.
Nearly immediately, the yield on the 10-year Treasury Note fell below 2% since November of 2016. CNBC describes 2% as “a key psychological level”, though such language is, at best, nebulous.
Regardless of the “psychological significance” of the fact that the 10-year note dropped below 2%, substantial downside moves in that key interest rate can absolutely have a serious impact on everyday financial issues for normal Americans.
For example, it is well known that lower interest rates tend to benefit two broad groups of people: Those investing in equities (stocks) and those seeking to acquire real estate-backed mortgage loans. In the case of stocks, businesses benefit from lower interest rates because it translates quite directly into lower expenses.
As for potential mortgage borrowers, lower rates translate into the option to purchase a higher-priced home without monthly payments being affected.
The 10-year note is also broadly considered to be the most important debt instrument in the world. Its popularity is driven by the fact that it is guaranteed by the government of the United States, and thus the risk of default is historically nearly non-existent.
But the most interesting feature of the Federal Reserve’s June policy report is the suggestions it makes about the future of another key interest rate: The Fed’s overnight lending rate. This is the interest rate to which the media refers when they make announcements concerning “interest rates” as a whole.
A review of the June policy report suggests that the Federal Reserve does, in fact, foresee a drop in interest rates, but the big question concerns the timing of any such changes. There are two different clues embedded in the June report that suggest such a change may be more imminent than previously thought.
The first clue is the tally of an indicator vote regularly taken at Fed meetings to identify how many of the Federal Reserve Board Governors are open to considering a rate cut by the end of the year. In this month’s vote, there was one more vote expressing that openness than there was in previous editions of the same poll.
However, the consensus position remains that if a rate decrease happens, it is most likely to happen in 2020.
The second clue is more subtle, but certainly important: The wording of the Fed’s statement changed. The May policy statement described the attitude of the Fed Governors as “patient” as it determines how to move forward with interest rate adjustments.
In the June report, the word “patience” was removed in favor of a commitment to “closely monitor” the situation.
The most relevant question, however, is “why” is the Fed considering these rate cuts?
The answer is connected to the risk of trade wars with China and the volatility that could result in U.S. markets as a result.
As such, it remains a wise idea to carefully hedge your portfolio against market volatility.
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