Let’s Talk About That Fed Rate Cut

The Federal Reserve cut its benchmark interest rate by 0.25% yesterday. They decided that the risks to the job market were greater than the risk of rising inflation.

We’ll see about that. They may look back on this six months from now as a major unforced error if inflation really is trending higher again. But for the moment, lower rates are the reality.

This was arguably the most anticipated rate decision in history given the political intrigue surrounding it. President Trump has been loudly pressuring the central bank to cut rates, going as far as to threaten to fire Chairman Jerome Powell and actually firing Governor Lisa Cook (though the courts have put that firing on hold for now.)

So, now what?

Let’s talk about what that means for our stock portfolios… and everything else.

What Did the Fed Actually Say?

The Fed funds rate is now 4.00% to 4.25%.

No big surprise there. The futures market had priced in a better than 90% likelihood that Powell & Company would do exactly that.

Mr. Market was far more interested in what the central bank had cooking for the rest of this year and beyond.

And that’s where it gets interesting.

Each policy meeting, the members of the Fed Open Market Committee (FOMC), the body that sets rates, does an internal poll of where each member thinks interest rates should be. This is the infamous “dot plot” you hear mentioned in the financial press.

We’ll ignore for a minute the arrogance of a committee of banking bureaucrats believing they can set the price of money better than the invisible hand of the free market. That’s not a battle we’re going to win today.

Instead, let’s take a look at what the Fed folks are saying so that we can get a better idea of what to expect from them over the next few months.

Here’s the dot plot in all its glory. If it looks like incomprehensible hieroglyphics to you, don’t worry. I’ll be your Rosetta stone. I’ll walk you through it.

FOMC Dot Plot for “Appropriate” Fed Funds Rate

Let’s look at 2025. One member of the committee believes rates should be pegged at 4.25% – 4.50%, or the rate in place before Wednesday’s cut. I suppose that’s what passes for a hawk these days. Another six members believe rates should stay parked at 4.00% to 4.25%.

The lion’s share of the committee – nine in total – wanted to see rates at 3.50% to 3.75% before year end, suggesting two more rate cuts from here.

And one wild cowboy believes the Fed should slash rates another 1.25% all the way down to 2.75% to 3.00%.

They don’t tell us who voted for which dot, as they intentionally keep it anonymous. But my money for that exceptionally low dot would be on the newest addition Stephen Miran.

Miran is the architect of the “Mar-a-Lago Accord,” which proposed lowering the value of the dollar to boost exports. He’s also well known to be an uber dove and a believer in low interest rates.

The dot plot is not chiseled in stone. It’s a snapshot of the Fed decisionmakers’ thinking at a single point in time and can turn on a dime. But for the time being, the Fed is telling us that they expect rates to be about half a percent lower by the end of the year and roughly another half percent lower by the end of next year.

What’s the Real Rate?

Remember, the rates the Fed sets are nominal rates. That means they aren’t adjusted for inflation… inflation that happens to still be clocking in at around 3% per year.

That means that the real, inflation-adjusted rate will be a measly 0.50% to 0.75% by year end.

You’re not exactly getting rich on that.

Meanwhile, the Fed’s expectations for GDP growth aren’t exactly inspiring either. The average estimate among the Fed’s committee members was that the economy would grow at less than 2% per year through at least 2028. And they don’t expect inflation to return to their 2% target until 2028.

In other words, the Fed is telling us that they expect stagflation: sluggish growth combined with sticky inflation.

Great.

What can we do about it?

Not a whole lot, unfortunately.

The Fed has aggressively suppressed interest rates for most of the past 25 years. That’s not going to change any time soon. And, all else equal, that means persistent inflation, flat bond yields and a weaker dollar.

The only thing you can really do is protect yourself with inflation hedges. Gold should be part of that story. If you don’t already own gold, you should make it part of your allocation.

High-quality stocks are good long-term inflation hedges too, though it does look more and more like stocks are in a bubble. This probably isn’t the best time to add major long-term stock exposure.

Perhaps the best advice is simply to stay nimble and get more comfortable with shorter-term trading. You can buy expensive, bubbly stocks so long as you have rules in place to sell them if the trade goes the wrong way on you.

And finally, keep a little extra cash on hand. Yes, I realize I just told you that the Fed is devaluing that cash… and thus I’m recommending you keep a larger-than-usual piece of your portfolio in something virtually guaranteed to lose value.

Remember, it’s a tactical move, not a permanent one. And cash still represents dry powder that you can put to work in the event that we see some market volatility before year end.