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  • Speculation about whether the Fed will cut interest rates can generate a lot of headlines,

  • but it's not always clear how a rate cut might affect investors.

  • So let's discuss how lowered interest rates can stimulate the economy and impact the financial

  • markets.

  • Also, let's take a look at which types of investments have historically performed the

  • best in low interest rate environments.

  • The goal of the Federal Reserve, or "the Fed", is to keep the U.S. economy healthy

  • in two ways: minimize unemployment and stabilize inflation.

  • The Fed does this is by decreasing or increasing interest rates.

  • Historically, as the economy has shown signs of weakness, the Fed has responded by cutting

  • interest rates.

  • Here's how it works: a committee within the Fed called the Federal Open Market Committee

  • meets eight times a year to look at the health of the economy.

  • If there are signs of a weak economy like rising unemployment, stagnating job growth,

  • or increasing prices of everyday goods the Fed may decide to lower interest rates.

  • Specifically, the federal funds rate.

  • Generally, when the federal funds rate is low, banks lower their interest rates.

  • This can help stimulate economic growth in a couple ways.

  • First, lower interest rates make it cheaper for people and businesses to borrow money

  • for big purchases or new ventures.

  • Second, cutting interest rates makes it less profitable to keep money in bank accounts.

  • Instead of saving, individuals and businesses may want to invest or spend that money.

  • The goal is to kick-start a virtuous cycle of spending and growth that creates jobs and

  • steers inflation to more healthy levels.

  • However, it'll likely be some time after the Fed cuts rates before consumers begin

  • to feel this type of economic growth.

  • Though the economy responds slowly, you may see changes in the stock and bond markets

  • immediately.

  • For major stock indices, rate cuts are typically good news.

  • While expectations are often priced in, sometimes there's a surprise that can cause the market

  • to spike.

  • In fact, sometimes just rumors of cuts can cause a rally.

  • For example, in June 2019, Fed chairman Jay Powell assured that the Fed would act as

  • appropriate to sustain the expansion, many investors interpreted this as a hint that

  • interest rates could be cut.

  • As a result, stocks soared, and the Dow broke its six-week losing streak.

  • In general, the S&P 500 Index has generally performed well following interest rate cuts.

  • This may be partially due to economic recovery but could also be due to investors' increased

  • optimism.

  • Interest rate cuts can also have a major impact on the bond market, driving demand for bonds

  • higher.

  • This is because if interest rates are going to be lower, older bonds with higher interest

  • rates become more valuable.

  • For investors who already own bonds, interest rate cuts can potentially allow them to sell

  • their bonds for a higher price on the secondary market.

  • Over the past 46 years, the performance of stocks, commodities, REITs, and gold was relatively

  • balanced.

  • But during low interest rate environments, REITs and U.S. stocks have been the highest

  • overall performing asset classes.

  • Because interest rates are typically cut during economic slowdowns, defensive stock sectors

  • may be better poised to weather low interest rate environments.

  • Think of it this way reduced rates in bonds may cause investors to look for income streams

  • elsewhere.

  • This can cause increased demand for stocks that are known for their steady dividends,

  • like real estate, utilities, and telecom.

  • Consumer staples may also be a good investment during a rough economy because people will

  • always need food.

  • Plus, these stocks tend to pay dividends as well.

  • But remember the point of cutting interest rates is to nudge the economy in the opposite

  • direction.

  • Though cuts may be the result of a negative economic outlook, forward-thinking investors

  • may want to anticipate how interest rate cuts may help spur long-term economic growth.

Speculation about whether the Fed will cut interest rates can generate a lot of headlines,

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