In a video from late 2023, Graham Stephan, a financial personality with a large YouTube following of over 4.6 million subscribers, discussed the Federal Reserve’s decision to pause interest rate hikes and potentially lower them in 2024. According to Stephan, this could have a significant effect on financial markets.
Why the Change in Fed Strategy?
In June 2022, the Consumer Price Index (CPI) surged to a remarkable 9.1%, indicating a significant increase in prices across various sectors compared to the previous year. In response to this alarming inflation rate, which far exceeded the Federal Reserve’s target of about 2% annually, the Fed embarked on an aggressive series of interest rate hikes.
Between March 17, 2022, and July 26, 2023, the Fed raised interest rates 11 times, pushing the federal funds rate from a range of 0.25%-0.50% to 5.25%-5.50%. This move aimed to curb inflation and prevent it from spiraling out of control.
In a YouTube video, Graham Stephan explains that the change in Fed strategy was prompted by the effectiveness of the interest rate hike cycle. By November 2023, data showed that the inflation rate had decelerated to 3.1%, a significant decline from the alarming 9.1% rate observed in 2022. While still above the Fed’s 2% target, this reduction signaled progress in addressing inflationary pressures.
Given that it takes time for interest rate hikes to permeate through the economy and influence consumer behavior, the Federal Reserve has opted to ease off its aggressive monetary policy stance, reflecting a cautious approach to managing inflation while supporting economic growth.
How Might This Affect Investments?
The shift in Federal Reserve policy from a cycle of interest rate hikes to a pause, with potential rate cuts on the horizon, has led to a significant change in the investment outlook. When interest rates and inflation are high, it increases costs for both consumers and businesses. This is reflected in higher loan costs across various sectors, including corporate loans, personal auto loans, credit cards, and home mortgages. The resulting increase in borrowing costs dampens overall demand in the economy, which can lead to lower earnings and stock prices, and may even elevate the risk of a recession and job losses.
However, when the Federal Reserve changes course and begins cutting interest rates, the opposite occurs. Lower interest rates translate to reduced borrowing costs for both businesses and individuals, effectively boosting their cash flow. This tends to stimulate demand for purchases typically financed through loans, such as homes and cars. Consequently, overall spending tends to increase, leading to higher corporate profits and stock prices.
Additionally, as interest rates decline, bond prices tend to rise. In general, stock and bond markets often perform well when the Federal Reserve is lowering interest rates, as opposed to raising them. This shift in monetary policy can have broad implications for investment strategies and asset allocation decisions.
How Is Stephan Responding?
Stephan’s approach to investing aligns with a long-term perspective rather than short-term trading. Regardless of changes in fiscal or monetary policy, or specific economic conditions, he maintains a consistent investment strategy.
In terms of his investment portfolio, Stephan emphasizes diversification across various asset classes. He allocates his investments across stocks, real estate, cash, treasuries, and a small amount of bitcoin. Despite potential fluctuations in the market, Stephan remains steadfast in his approach, emphasizing the importance of staying the course.
Stephan’s mindset reflects a focus on the long-term growth potential of his investments. He acknowledges that while positive market performance is desirable, he remains prepared for periods of market decline. In such scenarios, Stephan sees opportunities to acquire assets at lower prices, thereby enhancing his long-term investment returns.
What Is the Updated Status of Fed Cuts in 2024?
As of the end of February 2024, the outlook has evolved since Stephan’s video was posted in December 2023, particularly regarding the Federal Reserve’s monetary policy stance. Initially, there was anticipation that the Fed would begin cutting interest rates early in 2024. However, recent statements from Fed Chair Jerome Powell suggest otherwise. Powell indicated that a rate cut in March is highly improbable, leading economists to push back their predictions for the first rate cut to June or later.
This shift in the Fed’s timeline could alter the optimistic landscape that Stephan and others envisioned at the end of December 2023. Delaying rate cuts raises concerns among economists that the Fed might act too late, potentially causing the economy to slide into a recession. Moreover, prolonged uncertainty surrounding the Fed’s actions introduces a greater level of unpredictability into the investment landscape for 2024.
Despite these developments, financial markets have continued to trend positively, with the S&P 500 recently reaching a new all-time high and posting a year-to-date gain of 6.69% as of February 23, 2024. However, the longer the Fed delays rate cuts, the more likely investors may become apprehensive. Therefore, it is crucial to closely monitor any changes in the Fed’s approach and their potential impact on market sentiment and investment decisions moving forward.