The Federal Reserve’s stated dual mandate is for price stability and maximum sustainable employment. Price stability is a 2% inflation target, while maximum employment means keeping the unemployment rate as low as possible. The Federal Funds Rate (the rate banks charge each other for overnight lending) is the main tool used by the Federal Reserve to help control inflation and employment. The Fed Funds Rate and market demand then impacts all other rates such as government bonds, mortgages, and CDs.
The Fed recently lowered this rate by another 0.25% down to 2% due to slowing global growth and minimal inflation. Many might think 2% is extremely low, but we need to view this from a global perspective. The European Central Bank rate is currently at -0.5% and the Bank of Japan rate is -0.1%.
These negative rates are not typos. In these extreme cases, central banks around the world have actually pushed interest rates into negative territory. The goal of this policy is to encourage banks to lend out their money instead of storing it in cash, thus stimulating the economy. This also encourages savers to shift their money into more aggressive holdings to maintain their income needs.
Time will tell if this policy is successful or not, but it is rarely used. Who wins and who loses? Savers are hurt since they are penalized to hold cash, while bank profits are also squeezed since they can no longer charge high rates to lend out their money. On the other hand, borrowers benefit since it would likely result in very low interest costs for home and car buyers.
If global growth continues to slow, we will likely see more rate cuts by the Federal Reserve. However, we have a long ways to go before they could potentially turn negative like they are in Europe and Japan. That being said, it is becoming more difficult to generate income in this low yield environment. It might be tempting to shift money to higher yielding asset classes such as real estate, MLPs and “high yield” (aka. “junk”) bonds. However, maintaining your allocation to high quality bonds should provide downside protection during this late stage of the economic cycle.
|Asset Index Category||Category||Category||5-Year||10-Year|
|3 Months||2019 YTD||Average||Average|
|S&P 500 Index – Large Companies||1.2%||18.7%||8.6%||10.9%|
|S&P 400 Index – Mid-Size Companies||-0.5%||16.4%||7.1%||10.8%|
|Russell 2000 Index – Small Companies||-2.8%||13.0%||6.7%||9.7%|
|MSCI ACWI – Global (U.S. & Intl. Stocks)||-0.2%||15.8%||6.5%||8.4%|
|MSCI EAFE Index – Developed Intl.||-1.7%||12.8%||3.3%||4.9%|
|MSCI EM Index – Emerging Markets||-4.2%||5.9%||2.3%||3.4%|
|Short-Term Corporate Bonds||0.8%||4.1%||1.8%||2.3%|
|International Government Bonds||0.1%||5.2%||1.4%||1.6%|
|Bloomberg Commodity Index||-1.8%||3.1%||-7.2%||-4.3%|
|Dow Jones U.S. Real Estate||7.3%||27.9%||10.7%||12.8%|
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