hi I'm Jimmy in this video we're looking at how interest rate affect the economy
and how changes in interest rates can affect things for investors and then
ideally we can use this information to help us get closer to our personal goal
of achieving financial freedom okay so just a few days ago
the Federal Reserve lowered interest rates with the surprise 50 basis point
cut that's the same as 1/2 of 1% now this video isn't exclusively tied to
that particular cut this video is more designed for us to get a better
understanding of what happens in general when the Federal Reserve lowers interest
rates or if they raise interest rates well the opposite would happen okay so
this is a one-year chart of the Fed Funds target rate and clearly the 50
basis point rate cut from just a few days ago well that was not only bigger
than all the other cuts this year but it was also a bit of a surprise from a
timing perspective and impressively the stock market was down almost 800 points
on the day that they announced this rate cut despite the fact that generally
speaking interest rate cuts are designed to spur the economy higher now the
reasons behind this particular rate cut are slightly less important for the case
of this video instead let's focus on how this rate cut is intended to help the
economy ok now first and probably most obvious is that inch lower interest
rates affect the cost of borrowing money makes money easier to borrow for people
and businesses so if we're considering buying a house
well maybe lower interest rates are exactly what we need for us to buy today
because lower interest rates would mean a lower mortgage and a lower cost of
borrowing in general same thing if we're going to buy a car or any really big
purchase sometimes lower interest rates can help sway individuals that were
perhaps on the fence before and the same can be said for businesses if bennet if
businesses are looking to expand their business or upgrade equipment or maybe
make a new acquisition or possibly expand into a new market
well sometimes lower interest rates can give them access to the capital that
they need to do those things or perhaps the financing necessary to buy new
machines whatever it might be and in theory those
actions today help spur the economy forward since more people and more
businesses are spending more money and this is often a very popular technique
if an economy is in a recession it's a very popular technique to turn the
economy out of the recession it's a good way to start getting more people and
companies to spend again and in theory that should lead them out of a recession
or in the case of today's economy hopefully prevent a recession or at
least keep it further away than it is right now okay so that's simple enough
but now there's another effect we should consider so many investors are global
investors and when interest rates fall in the United States
well global investors and it doesn't really matter where they live well now
they have the choice do they invest in the US which is dollar denominated
investments or maybe the investment that maybe they decide to invest in something
that's tied to the Euro or the one or whatever it is point being that lower
interest rates can often lead to a lower currency value to illustrate that this
is a five-year chart of dxy which is the dollar index or one of the dollar
indexes and the ten-year Treasury and roughly speaking we can see that
oftentimes when interest rates go down or the dollar goes down when interest
rates go up the dollar goes up and we can see that this relationship doesn't
completely hold true all the times and that's largely due to the fact that a
currencies value is relative to other currencies so other central banks and
other countries interest rates play a role in this as well but roughly
speaking a common reaction to lower interest rates is a weaker currency so
that's something we should be aware of our next question is what performs well
with a weaker US dollar well oftentimes gold is a strong beneficiary of a weaker
dollar to illustrate let's jump back to the Great Recession and here we can see
that during the Great Recession when the dollar dropped well the US well goals of
the US dollar would drop and gold would rise now again it didn't always work
this way in fact the International Monetary Fund you might hear called the
IMF well they estimate that about 1/2 of the movement of the price of gold can be
explained by the movement in the u.s. dollar so perhaps gold is a good
hedge as rates as interest rates are dropping and also as investors are
fearing a pending recession or a further stock market crash gold could be a good
one to offset it this seems to be well positioned at this particular time now
another thing that's happening as a result of falling interest rates is that
bond prices move higher so we know that over the past year the Fed Funds rate
has been falling but then we switch this to TLT which tracks US Treasuries that
have a maturity of more than 20 years I believe and we could see that that price
the price of that of those bonds has consistently risen and then if we switch
from Treasuries over to triple-a corporate bonds well we can see the
triple-a corporate bonds are once again doing the very same thing and this makes
sense if we think about it since interest rates are falling while bond
prices would be rising since the two are inversely related
so as interest rates go one way bond prices will go the other way
well then perhaps we should allocate more of our capital towards bonds
particularly some of the more secure bonds now maybe we have no idea which
way interest rates are going to go not many people do but one thing we can do
is watch inflation since often lower interest rates and the subsequent pick
up in the economy can lead to higher inflation higher inflation can lead to
trouble for the economy and the Federal Reserve will usually jump in and start
increasing rates to try to get inflation under control and the whole thing sort
of swings in that that way over the long run so if we're curious this is what
inflation has looked like since the year 2000 and right now it's sitting at about
two-and-a-half percent which is a little bit on the high end but it's not that
high now that's also as of the end of January February numbers come out in the
next week or two so two and a half percent CPI just so
we're all in the same page what a two and a half percent CPI tells us is that
as of the end of January products broadly speaking are two and a half
percent higher than they were one year ago so if inflation were to
start moving higher in a meaningful way call it three three and a half four
percent well it's possible that the Federal Reserve jumps in and tries to
slow down the rise of inflation by spinning interest rates the other way
and move them higher now if on the flip side they stay low well like we said
investments like gold or bond bonds could look good so I think for now I
think it makes sense for us to stay a bit more defensive and then this brings
us to stocks so broadly speaking lower interest rates should imply a lower
required rate of return I've discussed that in some recent videos but that's
not the only reason why interest rates should do better for the economy for for
at least for the stock market because of the whole spurn spending that I
mentioned a few moments ago well that spurn spending is likely to
lead to higher revenue for companies higher profit margins for companies and
overall the stock market should continue to move higher now I would caution us
from not overreacting to any one day or one month or one quarter or one piece of
news a good example of that is the start of this video I said I was surprised at
the Fed cut rates by 50 basis points and I was surprised as stock market was down
that day that's a good example of what not to do that's way too short-sighted
what I think makes the most sense is for us to make adjustments to our investment
portfolios based on the big picture trends that we're seeing it seems to me
that what the Federal Reserve is doing is they're trying to kick the can down
the road and because of that the stock market could resume higher over the next
year or two and that being said I think it could make a lot of sense to stay
invested in the stock market now about a year ago I did a video called can the
stock market keep moving higher and I referenced Warren Buffett saying that he
thought that stocks could keep going up and that was very much at that time tied
to falling interest rates and once again we're in a very similar position except
this time they're falling even faster than they were originally expected to
back then so if you're curious that could be a good next video for you to
watch if you're curious about how far interest rates can go about affecting
stocks there's a link right here in this link in the
scription below and I really want to thank you for sticking with me all the
way to the video I really appreciate it thanks and I'll see in the next video