Interest Rate Harvest
Many cultures of past and present have symbolized September as the harvest month. Throughout Switzerland, the word used in place of September is Herbstmonat, which translates to harvest month. Former Anglo-Saxon tribes who used to inhabit parts of Great Britain knew September as barley month called Gerstmonath. Financially and metaphorically speaking, this September harvested the first federal interest rate cut in a series of future cuts expected for the economy since the Federal Reserve raised monetary policy rates eleven separate times, starting in 2022.
The Federal Reserve reduced monetary policy interest rates by one-half percentage point after the Federal Open Market Committee met in September. The federal overnight annualized interest rate effectively declined to five percent from the five and one-half percent that used to run the economy.
Financial markets barely budged when the Chairman of the Fed delivered the news. Investors felt highly certain the Fed would reduce rates in September, which met market prices already included that information on the day of the cut. However, the next market day opened with significant investor demand for small-cap equities. As a result, this year’s small-cap equity returns took a meaningful step higher in what seemed like a blink of an eye. When small caps receive that much interest, it can sometimes serve as an early expansionary signal since small-cap industries are far more sensitive to the domestic affairs of businesses and banks.
Bond investors who have braved the higher interest rate cycle over the past couple of years may have observed their fortunes change as of late. The federal interest rate cut helps lessen the risks that market interest rates will move much higher from here. In addition, it can increase investor confidence that the worst inflation is over, so investors can likely worry less about unexpected future shocks that subtract from their investments. Bond market returns are up handsomely this year, bringing medium to long-term bond market returns closer to the market yields that existed back when investors originally invested.
Another neglected market area that suddenly reversed and gained investor attention in September was emerging market equities. For quite some time, investors have seemingly been disinterested in emerging markets encompassing places in China, India, Brazil, and many more geographies. The federal interest rate decision helps emerging markets since many emerging market debts use US interest rates to benchmark the debt’s coupon payments. However, China’s government announced plans to stimulate its economy and expand economic production, which might have had a bigger effect than the US interest rate announcement. Investors may now find Chinese equity valuations attractive if China’s economy is about to re-enter a new growth cycle after being economically hurt by over-inflated and leveraged real-estate developments.
The US dollar has strengthed since the federal rate dropped after mild weakness in the weeks leading up to the interest rate decision. Some investors may have expected the US dollar to stay in its weakening channel after the interest rate cut, given that the US interest rate advantage narrowed by one-half percent. Instead, the US dollar showed strength, which again seems like a favorable reaction that can happen before the economy returns to growth and productivity. Strong demand for US dollars gives the impression that investors badly desire US investments, likely because the US has continued to exceed in many areas, such as innovation, competition, and property protection.
This year’s September harvest produced a federal interest rate cut and broader participation in capital markets that have fallen behind other comparisons that occupy a much narrower space, which can feel crowded and concentrated. In any event, now that the first official interest rate cut is registered, the path forward for monetary policy seems headed in a better direction, with future decisions centered around reaching economic normalization and federal policy stabilization as quickly as possible. Hopefully, new and future policy accommodations will harvest in another economic expansion, which investors won’t want to miss.
