Interest Rate Drop - How Will That Impact Investments?

The Federal Reserve will decide this month whether to increase interest rates or keep them the same. There is little chance rates will rise due to the concerning labor and inflation reports we have seen in the past couple of weeks. The expectations are for a quarter or half-point reduction in the Fed Funds rate, which then prompts reductions in most interest rates.  

The risk confronting the Fed would be to lower interest rates in an economy that perhaps has not felt the full brunt of the tariff wars yet. Interest rate increases and decreases may impact investments, especially in the short term. However, investing for the long term is recommended for those who have identified future goals to achieve.

The following is a description of broad categories of investments and how interest rates can affect them:

Cash/Money Market/CDs

The higher-than-normal rates on short-term cash investments over the past few years have provided investors with relief from potential losses due to the lasting effects of the pandemic and the volatile political environment in which we find ourselves. The higher yields on cash investments have allowed investors to construct more conservative portfolios without sacrificing higher returns too significantly. In comparison, due to the financial crisis that began in 2008, the average yield for money market funds from 2009 to 2012 was extremely low, often at or near 0%¹, which forced investors to accept greater risk if they sought higher returns. The inflation rate for the past 12 months is 2.90%². Even if interest rates decline, the yield on short-term assets should still outpace inflation.

¹ Bankrate Aug 2025
² Aug 2025 Consumer Price Index, Bureau of Labor Statistics 

Bonds

A bond is a type of loan that an investor makes to a borrower, such as a government or corporation, for a set period, with the promise of receiving periodic interest payments and the return of the original principal amount on the bond's maturity date. Bonds are considered a stable form of investment and a key component in many portfolios, as they provide a steady stream of income and can help offset the volatility of stocks. Bonds are sensitive to changes in interest rates. When interest rates go up, bond prices go down, and vice versa. For example, during 2022, the inflation rate rose dramatically due to pent-up demand and price increases following the pandemic. The Fed’s monetary policy to halt inflation is to raise interest rates. The aggregate bond index lost 13.0%³ - a stunning decline for a supposedly conservative investment. Eventually, interest rates should fall to long-term averages, and longer-term bonds (Corporate bonds, Municipal bonds, Long-term Government Securities) will benefit the greatest.

My investment philosophy is grounded in academic evidence and the application of sound diversification principles. Bonds are a crucial component of a portfolio, serving as the primary diversifier to stocks and riskier investments. Bonds can be broken down further into short-term and long-term, but the decision to include them in a portfolio shouldn’t be based on the direction of interest rates. Bond performance can be traced to two factors – the credit quality of the issuer and the length of maturity. Typically, the lower the credit rating and the shorter the bond maturity, the lower the yield, and vice versa.  

 Stocks

The value of a company's stock reflects the expected amount of future earnings for that company. The stock market usually reacts positively to interest rate reductions. Interest-rate-sensitive industries, such as the housing industry, could spark tremendous economic activity, which could increase stock prices. On the other hand, the activity surge could also ignite higher prices and force interest rate increases to hold off inflationary pressures. A reduction of interest rates would usually benefit a company by:

·         Lowering the borrowing costs for the company would increase the likelihood of additional borrowing for expansion and hiring.

·         Lowering the borrowing costs of consumers could free up more discretionary income to purchase goods and services.
 

Currency (Dollar)

Foreign Governments own approximately $9 trillion (30%) of all U.S. Debt held by the public. Lower interest rates may discourage foreign investors from purchasing U.S. Treasury Bonds⁴ and buy elsewhere that has higher rates, which could lower the exchange value of the U.S. Dollar relative to other countries' currencies. On the other hand, a lower U.S. dollar may make U.S. exports increase since the lower dollar can lessen the costs for foreign importers.

⁴ U.S. Treasury

 Of course, there is a potential factor at play here that would make normal free-market reactions to economic data a lot less probable. The proverbial “elephant in the room” is tariffs and, more specifically, unilateral actions by our government that make free markets less independent. 

Please visit our website to learn more about the services I provide. I offer a no-charge consultation either in person or by phone (925) 484-1671. Please feel free to schedule an appointment or ask a question you have.  

Thank you,

Anthony B. Carr
CPA, CFP®, MBA

Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. Diversification neither assures a profit nor guarantees against loss in a declining market. There is no guarantee that strategies will be successful.