How Interest Rate Moves Affect The Market
How Interest Rate Moves Affect The Market
On December 18, 2024, the Federal Open Market Committee cut the fed funds rates for the third consecutive time this year. This action indicates that the economy has slowed too much despite increased inflation, as measured by the rise of the Consumer Price Index. The Federal Reserve has a directive from Congress to maximize employment and stabilize prices. The decision to lower the short-term interest rate will hopefully spur personal and business spending and return inflation to the two percent target.
In 2024, the U.S. economy has demonstrated resilience, characterized by robust labor markets, moderate inflation, and consistent consumer spending. However, uncertainties persist, especially concerning inflationary pressures, labor markets, international conflicts, and pending political policy changes.
The Federal Reserve is exercising caution as it tries to balance its monetary policies. If it doesn't lower the rate promptly, the economy could potentially enter a recession. On the other hand, if it doesn't raise the interest rate soon enough, there is a risk that inflation could spiral out of control.
What impact does a rate cut have on the stock market? As we saw this week, if investors perceive the cut as a sign of potential economic weakness, the market may fall in the short term. However, making investment changes based on Federal Reserve policy can result in emotional decision-making and undermine your long-term investment success. If you try to buy or sell based on short-term Fed movements, you might be trapped in a cycle of fear and greed, chasing market trends instead of adhering to a disciplined investment strategy. This behavior can result in costly mistakes, such as selling during market downturns or missing out on potential gains by remaining on the sidelines.
While Federal Reserve policy is undoubtedly an important factor in financial markets, it should not influence your long-term investment strategy. Prioritize creating a diversified approach that considers various factors, particularly personal goals and risk tolerance. By doing this, you can effectively position your portfolio for success, regardless of the Fed's actions in the coming months and years.
Sources:.
https://www.federalreserve.gov/monetarypolicy/files/monetary20241218a1.pdf
https://www.federalreserve.gov/monetarypolicy.htm
