The market has had a rough go of it lately thanks to two recent events we haven’t seen since 2008. On July 31, the Federal Reserve announced that it will cut rates by .25%. Only a few days later, the Chinese yuan fell below an exchange rate of 7-to-1 compared to the U.S. dollar, which poured fuel on an already-stoked trade fire. The market’s reaction to both events was sharp but for different reasons. Understandably, you might be wondering how your portfolio could be affected.
Lowering benchmark interest rates is a common form of expansionary monetary policy* used to help lower unemployment rates, increase wages and stimulate economic growth. In theory, when the Fed reduces the cost of borrowing money, banks should have an easier time lending money to consumers for things like mortgages, cars or investments. It can also stimulate bonds to help companies expand or make additional capital investments.
The Fed made an unusual move to cut rates while the U.S. economy appears strong**, citing trade and global weaknesses*** as primary drivers of its decision. The rate cut was intended to give the economy a jolt of energy and help extend our decade-long bull market. However, the market reacted poorly to the decision – with the consensus being that the Fed should have lowered rates by .50% instead of .25%. Although the cut didn’t have the immediately desired effect, cutting rates further could yield a positive market reaction and impact on equities.
The devaluation of China’s yuan roiled markets on Aug. 5. A weaker yuan might help Chinese exporters cope with U.S. tariffs, but also it poses some significant global risks. A weaker yuan could push capital out of the Chinese economy and lead to volatility in the global currency market*****. China’s central bank maintains that the yuan was not devalued on purpose****, but its refusal to protect the 7-to-1 artificial barrier could be interpreted as the latest barb in an ever-escalating trade debate with the United States. Prolonged trade instability between the two countries could lead to further market volatility.
Despite negative market reactions to recent events, it’s important to not make rash decisions. During times of volatility, remember that a well-diversified portfolio and sensitivity to your personal risk tolerance are the cornerstones of wise investing – as is having a trusted advisor to call when you get nervous.
Blog by Andrew Gaskill, Financial Services Manager.