Key Questions: What Happens If the Fed Doesn’t Cut Rates This Year?

At the beginning of 2024, there was quite a bit of optimism premised on lower interest rates and predictions for numerous interest rate cuts by the Federal Reserve (“the Fed”) during the year. Futures markets were predicting at least six cuts and the Fed was signaling three cuts during 2024.¹ After surviving a brutal 16-month rate hike cycle that saw short-term interest rates surge by 500 basis points (5%),¹ investors entered the year with high hopes of falling rates, rising bond prices, higher stock prices, lower mortgage rates, and lower credit card rates. Confidence abounded. 

Now we find ourselves almost halfway through 2024 and many are asking, “What if the Fed doesn’t cut rates at all during the year?” 

What would that mean for bond prices, stock prices, and other investments? We will start with an easy one.

For the past 12 months, investors have enjoyed the option of stashing money in high-quality money market funds and earning roughly 5% with little or no risk to principal.¹ Not too shabby coming out of a near zero interest rate environment in 2022.

If the Fed does not cut rates this year, money market funds will continue to offer a high rate of return near that 5% area. Of course, those who stayed in cash in 2023 missed the spectacular 26% return posted by the S&P 500 Index.¹

Predicting what a “no-rate-cut" or "delayed-rate-cut” environment would mean for bonds and stocks is a little trickier. One of the main drivers of bond prices (and interest rates in general) is inflation. More specifically, expectations for future inflation are a major determinant of bond prices and the future path of interest rates.

If investors expect high inflation, they will demand a higher yield to compensate them for their diminished purchasing power. Currently, the Fed Funds Rate approximates 5¼%.¹ This is the short-term rate set by the Fed, and is a key component of its monetary policy toolkit used to influence inflation.

Longer-term interest rates, such as the 10-year U.S. treasury yield, are set by the market (think supply and demand), or buyers and sellers. Currently the 10-year U.S. treasury bond is yielding around 4¼%.¹ This current rate, which is about 1% below the overnight Fed Funds Rate, signals bond traders are thinking that the Fed Funds Rate will be coming down in the future and trending below 4 ¼% (otherwise they would just invest short-term at 5.25%).

If the Fed does not cut rates due to concerns that inflation is not approaching their 2% target quickly enough, it could put pressure on longer-term bond prices; bond investors will demand higher yields if they think inflation may be trending higher.

Faster-than-expected GDP growth and strong employment do not necessarily mean higher yields for bonds such as the 10-year Treasury. However, if the Fed ends up deciding not to cut rates in 2024 due to persistent inflation concerns, we would expect this to put downward pressure on longer-term bond prices. The reason for a delay in cuts is important to know in handicapping how bonds will react in the second half of the year if the Fed stays on hold.

Stock prices are driven by earnings, and earnings have been good. Certainly, investors have hoped for several rate cuts in 2024 to further fuel the strong stock market rally seen in the past 18 months. Lower interest rates increase the value of those future earnings, so all else being equal, lower rates are good for stocks and provide a tailwind.

However, it is hard to argue that stocks must go down if the Fed Funds Rate is left unchanged, as stocks are driven by variables other than interest rates. We mentioned the rally of 2023 that posted 26% returns, most of which occurred at the current Fed Funds Rate of 5¼%. We can also look at year-to-date returns. The S&P 500 is currently up over 10% year to date.¹ It is hard to say that stocks must go down if the Fed does not cut rates, when they have rallied so strongly while in this 5 ¼% rate environment.

If the economy continues to expand at a reasonable pace in the second half of 2024, stock prices could remain at current levels, or trade even higher due to ongoing enthusiasm for Artificial Intelligence coupled with the belief that a strong economy typically results in strong corporate profits. But should inflation persist and higher rates result, already elevated valuations could limit upside or possibly result in an adjustment in stock prices. 

The Fed is hoping to engineer a soft landing for the economy. A soft landing is loosely defined by the Fed being able to increase interest rates enough to slow the pace of inflation without putting the economy into a recession. While the Fed has a dual mandate of maximum employment and price stability (think low-to-modest inflation), they are more focused on reaching their inflation goal, as we are currently near full employment. Moreover, the Fed has stated repeatedly that high inflation acts as a tax on the economy and hurts everyone.

It is highly unlikely that the Fed will cut rates at this week’s meeting. We do anticipate one rate cut before the end of the year. But even if there are no cuts in 2024, we believe it makes sense to stay fully invested in a high-quality, well-diversified portfolio, for it suggests a healthy economy is persisting. If there are no cuts, the 5% money market rates will stay with us for longer. That said, while the high yields of cash are tempting, they continue to come with opportunity costs, and we believe investors will be better positioned to achieve their long-term goals by diversifying into other asset classes.

For more information, please contact your advisor.