- On 31 July the Federal Reserve cut rates by a quarter of a point, the first cut since the 2008 crisis.
- It cited the trade war and global weakness: a preventive move, not a response to a crisis.
- With lower rates, it is worth reviewing loans, deposits and the cash cushion in case the cycle weakens.
On 31 July 2019 the US Federal Reserve cut interest rates by a quarter of a point, the first cut since the 2008 crisis. The central bank justified the decision by citing the trade war and weakness in the world economy. The cut ended a period in which rates had tended to rise, and marked a change of direction compared with previous years. Although the move was small, it confirmed a turn in the direction of the central bank of the world’s largest economy.
Although the cut was small in absolute terms, its value as a signal was large. When the Fed changes direction, markets and other monetary authorities take note, and expectations on financing, currencies and returns adjust. For companies and families, the question was what that change meant for their own debts, savings and investment plans.
What a quarter point means
A quarter of a percentage point is a small cut in absolute terms, but it has symbolic and practical value: it indicates that the central bank believes the economy needs a little more support. It makes financing cheaper and is often reflected in the rates of other economies and in market expectations of what will come next.
Its effect on a specific family or company depends on how their finances are structured. Someone with loans linked to variable dollar rates may feel relief, and someone with savings in deposits may see them yield less. In the European setting, the effect is more indirect, through expectations, currencies and the general tone of the markets. If the economic cycle changes, so do the conditions of loans, deposits and markets, and the financial plan should take that into account.
One reason: uncertainty
Those two reasons, the trade war and a weaker world economy, show that it was not about reacting to a crisis, but about anticipating the impact of uncertainty on investment and trade. It is a preventive measure, designed to stop a cooling from turning into something bigger.
For companies, that means the external environment is perceived as more fragile. When central banks consider it necessary to act preventively, it is usually because they see risks on the horizon, even if these have not yet materialised. It is a signal to assess one’s own exposure to international markets, to currencies and to customers or suppliers located in economies highly sensitive to trade.
What to watch
Lower rates help those who borrow, but they reduce the return on traditional saving. It is a combination that invites a review of how loans and deposits are structured, and of how much cash is tied up without a clear purpose. A low-rate environment makes it costlier to leave money idle.
It is worth reviewing how much room there is in the cash position if the economic cycle weakens, and what would happen to income in a lower-activity scenario. It is a useful conversation to have with a financial adviser, without implying buying or selling anything in particular: it is about checking that the structure of debt, liquidity and objectives is consistent with a more uncertain environment. It may be a good moment to talk with the adviser about investment horizons, liquidity needs and currency exposure, always from the perspective of one’s own plan.
When central banks act, it is a signal to review one’s own exposure.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
