US Fed makes big interest rate cut. How does it impact your investments?

What happened?

The US Federal Reserve (Fed) has finally cut its benchmark interest rate. 

While the rate cut has been widely anticipated, I was eagerly awaiting to see if it would be a 0.25% or 0.5% rate cut. 

The Fed decided to go big – and opted for a 0.5% rate cut in its first interest rate cut in four years. 

Following the announcement, there was a lot of discussion in the Beansprout community today about how the rate cut may impact our investments. 

Let us dive deeper to find out more about the Fed’s latest interest rate decision, and understand what this may mean for fixed deposits, T-bills, stocks and REITs. 

What we learnt from the US Federal Reserve Rate Cut

#1 – Fed cuts interest rates by 0.50% as widely anticipated

At its latest meeting, the US Federal Reserve announced that it is cutting its benchmark interest rate by 0.50% or 50 basis points.

The benchmark rate will decline from the range of 5.25% to 5.5% currently to 4.75% to 5%. 

This would be in line with market expectations, as investors have raised their hopes of a sharp rate cut in recent weeks. 

The rate cut would also represent the Fed’s first interest rate cut since the Covid-19 pandemic, where interest rates were raised to bring down inflation. 

The big interest rate cut follows “greater confidence” that the US Fed has gained about inflation, as the headline inflation has moderated to 2.5% in August 2024.

The Fed benchmark interest rate is the interest rate that US banks borrow and lend to one another overnight, and tends to affect the borrowing and savings rates for US consumers. 

With the rate cut, the Fed is looking to support the US labour market in addition to bringing inflation back to is goal. 

#2 – Fed expects further rate cuts in 2024 and 2025

Many investors were also looking out for the Fed’s interest rate projection beyond the first rate cut, which is reflected in the ‘Dot Plot’.

According to the latest projections, 10 out of 19 officials saw interest rates being cut by another 0.5% by the end of 2024, and a further 1.0% in 2025. 

This would bring the Fed’s benchmark rate to 3.25% to 3.5% by the end of next year. 

Investors have been hopeful of a more aggressive interest rate cut by the Fed, with investors assigning more than a 50% probability that the Fed will cut interest rates by at least another 0.75% by the end of this year, according to the CME Fedwatch Tool as of 19 September. 

Likewise, investors are expecting that the Fed will cut interest rates by a further 1.25% in 2025, a sharper decline compared to the Fed projection.

This would bring the Fed benchmark rate to a range of 2.75% to 3.0%, compared to the Fed projection of 3.25% to 3.5%.

#3 – Terminal interest rate may be higher than long term rate

Despite the big rate cut, Fed officials raised their projection for the long term benchmark rate to 2.9% from 2.8%.

Fed Chairman Jerome Powell noted that it is unlikely that interest rates will return to the low levels that were seen in 2010-2020. 

This would represent a significant increase from 2.5% in December, and would mark the highest terminal interest rate since 2018. 

How does it impact your investments?

#1 – Bond yields have fallen sharply recently

Investors have been increasingly expecting a sharp interest rate cut by the Fed in recent weeks, which led to a significant decline in US government bond yields.

For example, the US 2-year government bond yield fell to 3.6% from a recent high of close to 5.0% as recent as in May this year. 

Following the Fed announcement, the rebounded slightly, likely due to Jerome Powell’s comments that there will not be a recession, as well as the higher terminal interest rate projection.

Singapore government bond yields have fallen sharply with the decline in the US government bond yields. 

The 6-month Singapore T-bill fell to 3.1% in a recent auction on 12 September, from a recent high of 3.76% in the auction on 6 June. 

As bond prices are inversely related to bond yields, this would mean that we have seen bond prices moving up in recent months as well. 

#2 – Fixed deposit and savings rates have declined too

With the fall in Singapore government bond yields, fixed deposit rates and savings account rates have also declined sharply in recent weeks. 

The best 6-month fixed deposit rate has fallen to 3.2% p.a., while the best 3-month fixed deposit rate has fallen to 3.15% p.a. as of 16 September.

Likewise, some banks have started cutting the interest rates on their savings accounts too.

#3 – Stocks have performed well historically following rate cuts 

The S&P 500 has posted gains in previous rate cut episodes, with a positive total return seen in 12 out of 13 occasions from the time the Fed starts cutting interest rates to the time the Fed starts raising interest rates again. 

The gains have ranged from 14% to as much as 151% over these periods. 

In terms of strategy, value stocks have outperformed growth stocks in all of the previous episodes. 

What would Beansprout do?

If you are still looking for a place to park your savings, it may be worthwhile locking in the interest rates before they decline further. 

For example, the 10-year average return for the current issuance of the SSB is 2.77%, while our projections indicate that is may fall further to 2.51% for the next SSB issuance. 

You may also check out our comparison of T-bills vs fixed deposits to find out how to earn the highest yield on your savings. 

While stocks have performed well historically following an interest rate cut, I would be mindful of the elevated valuation of the S&P 500 index, which is currently 32% higher than its historical average since 1990. 

Singapore REITS have also done well historically with interest rate cuts, as they can potentially benefit from lower borrowing costs. 

Check out our best Singapore REIT screener to find the best REIT for your portfolio. If you would like to gain exposure to a diversified portfolio of Singapore REITs, you can also consider a Singapore REIT ETF.

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