On September 18th, the Federal Open Market Committee voted to reduce the fed funds target rate by another 25 basis points (.25%). This rate cut was expected, but not guaranteed based on a series of comments made by Fed Chairman, Jerome Powell, over the past several weeks. According to Powell, today’s rate cut was made in an effort to extend the current economic expansion in the United States in light of global economic concerns.
Over the past few quarters, Destiny Capital’s Market and Economy Report has highlighted a gradual decline in global economic conditions, particularly in the manufacturing sector. In measuring this, one of the key data points that Destiny Capital’s Investment Committee tracks is the Purchasing Managers Index (PMI). The Purchasing Managers Index is constructed using a monthly survey taken by senior purchasing executives who report on conditions in areas such as new orders, factory output, employment, purchases, and supplier delivery times. We’ve tracked a steady decline both in domestic and international manufacturing PMIs over the past several quarters. The United States is somewhat insulated from this given that manufacturing represents approximately 11% of U.S. GDP. However, the PMI data from the Service Sector is also starting to indicate contraction. Given that the U.S. is a service-based economy, we are watching this very closely. We attribute much of the recent contraction to the uncertainty caused by the trade war between the United States and China.
The lack of progress being made in the current trade war is a lot like putting off a dentist visit when you first notice some minor tooth pain. The longer you wait to address the issue, the more severe the problem will become. What started out as a minor cavity can eventually turn into something much more painful and costly like a root canal – or worse. The longer this trade war extends, the more lasting the economic damage may become. This is no judgment on the strategy of the current administration. This is simply a fact of what we are seeing in both global and domestic data.
What Does This Mean for My Portfolio?
How the markets react in the coming days and weeks will likely depend on how the commentary made by Fed Chairman, Jerome Powell, is viewed. If his commentary is seen as stoking recession fears, we may see a near-term selloff in equities. However, the markets may respond favorably if Powell’s statements are interpreted as a bit more benign. The Fed is very adept at parsing words because each sentence is analyzed and scrutinized by investors across the globe, so monitoring the ongoing Fed commentary will be important.
Due to the rate cut, we expect the fixed-income portions of Destiny Capital’s portfolios to perform well, particularly bonds with longer durations as they are more sensitive to interest rate movements. How well they perform will depend on whether or not the markets have already ‘baked-in’ today’s rate cut to current prices. Regardless, we expect to see some appreciation in fixed-income assets.
No matter how the Fed’s messaging is received, we expect to see increased volatility as a result of the Fed’s decision to cut the fed funds rate - keeping in mind that volatility doesn’t always mean a sharp decline because volatility can be reflected in moves to the upside, as well. Regardless, we expect Destiny Capital’s fully diversified portfolios to effectively navigate any market volatility experienced in the coming weeks.
With This Rate Cut, Is Now a Good Time to Refinance My Mortgage?
This is a common question that we are asked during a rate cut cycle. Please keep in mind that movements in fixed mortgage rates are not directly correlated to movements in the fed funds rate. Mortgages tend to have much longer terms (10, 15, 30 years) while the fed fund rate is an extremely short-term (overnight) instrument. Therefore, fixed mortgage rates are more closely tied with movements in longer-term debt instruments such as the 10-year treasury, which was very low at 1.84% as of September 16th. In short, don’t assume that mortgage rates will drop in the near term just because the fed funds rate was cut. You are better off tracking movements in the 10-year Treasury when trying to gauge whether or not mortgage interest rates will be reduced in the coming weeks and months.
However, if you are considering a variable rate mortgage, these rates will be more directly impacted by a reduction in the fed funds rate. Most variable-rate mortgages are tied to the Prime Rate, which can be directly impacted by the fed funds rate. Therefore, a reduction in the fed funds rate might be seen as positive for holders of variable-rate mortgages.
It is our belief that future economic growth, or lack thereof, will depend on whether or not there is a resolution to the U.S. / China trade war. At the moment, the U.S. economy is being propped up by the consumer which, overall, is affirmative because consumption comprises roughly two-thirds of U.S. GDP. Generally speaking, consumers tend to focus on economic indicators such as the unemployment rate and wage growth, which have been positive throughout 2019. In fact, preliminary consumer sentiment recently came in at a strong 92.0. However, the consumer is often ‘the last one to the party’. We are already seeing a decline in fixed business spending due to trade uncertainty. If we continue to see a decline in other global and domestic economic indicators, we may start to experience wage freezes, layoffs and a reduction in hiring. This type of activity may eventually impact consumer sentiment and may cause a general slowdown in consumption. We don’t consider this imminent, but we are tracking these indicators very closely.
Please be assured that the Destiny Capital Investment Committee and our advisors are monitoring all aspects of the domestic and global economy very closely. We remain confident that our disciplined and diversified portfolios are well-positioned to navigate current market conditions. As always, please don’t hesitate to contact your Client Wealth Coordinator or Advisor with any questions.
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