As we move through another pivotal year for our economy, the Federal Reserve’s decisions are under intense scrutiny. With inflation pressures easing and interest rates at their highest in two decades, many are wondering: What comes next, and how will it impact my savings and investments? Let’s take a closer look at the role of the Federal Reserve, why high inflation is such a concern, why the Fed’s actions over the last few years have been critical in maintaining economic stability, and what we might anticipate in the coming years as the Fed potentially shifts towards lowering rates.

The Federal Reserve, often referred to as “the Fed,” is the central bank of the United States. Its primary mandate is to promote maximum employment, stable prices, and moderate long-term interest rates. In simple terms, the Fed’s job is to keep the economy running smoothly by controlling inflation and fostering conditions that create jobs.

One item in its toolbox is the ability to adjust the federal funds rate or the rate at which banks borrow money from each other. This baseline rate influences interest rates on everything from mortgages and car loans to the interest earned on savings accounts or certificates of deposit (CDs). When the economy is growing too quickly, leading to high inflation, the Fed raises interest rates to cool things down. Conversely, when the economy slows, the Fed can lower rates to stimulate borrowing, spending, and investment.

The Battle Against High Inflation

Inflation—the rate at which prices for goods and services rise—can erode your purchasing power and savings. That’s why the Fed takes it so seriously. Over the past two years, Fed Chair Jerome Powell and his team have been laser-focused on bringing down inflation, even if it meant risking a recession. This period of high inflation, driven by factors like supply chain disruptions and strong consumer demand, required aggressive action.

In 2022 and 2023, the Fed raised interest rates rapidly, reminiscent of the approach taken by former Fed Chair Paul Volcker in the early 1980s. Back then, Volcker pushed rates to very high levels to combat runaway inflation, which led to a painful but necessary economic downturn. Powell, however, has aimed to avoid that level of disruption, hoping for what economists call a “soft landing”—reducing inflation without causing a significant rise in unemployment or a major recession.

The Fed’s Recent Achievements and Challenges

As of today, Powell’s approach appears to be working. Inflation has fallen from over 7% to around 2.5%, close to the Fed’s target of 2%. The economy, while cooling, has remained resilient, and unemployment, though rising slightly, is still at historically low levels. If the Fed can stick this landing, it would be a significant achievement—perhaps even historic.

However, the job isn’t done. The next few months will be crucial. Powell and the Fed must decide how quickly and by how much to lower rates without reigniting inflation or stalling economic growth. Lowering rates too fast could undo the progress made, while moving too slowly could lead to a deeper economic slowdown.

What Happens as Rates Lower?

When the Fed lowers interest rates, borrowing costs decrease, encouraging more spending and investing. However, this also presents a challenge for those using fixed-income investments such as CDs, money markets, and high-yield savings accounts. While lower rates can indeed diminish returns on these products, there are effective solutions to help preserve and grow wealth in a declining rate environment.

For example, longer-term bonds tend to appreciate in value as interest rates decline, offering an opportunity to lock in higher yields now and benefit from potential price gains as rates fall. Additionally, equities often become more attractive in a lower-rate environment, as reduced borrowing costs can stimulate economic growth and potentially boost stock prices.

Diversifying your portfolio across various asset classes—including equities, bonds, and alternative investments—can help mitigate risk and ensure more stable returns, even as interest rates fluctuate.

Looking Ahead: What to Expect

As we look to the future, the Fed’s actions over the next year or two will be crucial. If inflation remains under control and the economy continues to show signs of stability, we might see a gradual reduction in rates. However, the Fed is likely to move cautiously, reducing rates slowly to avoid reigniting inflation or causing unnecessary economic turmoil.

As your investment advisor, we take our stewardship seriously, staying informed and prepared to adjust your portfolio as needed. In doing so, diversification remains key—balancing risk across different asset classes can help protect your portfolio in an uncertain environment. And remember, while lower rates might impact returns on some investments, they could also create opportunities in others, such as stocks or real estate.

Staying the CourseIn times of economic uncertainty, it’s easy to get caught up in the headlines and worry about what’s coming next. But remember, the Fed’s primary goal is to foster a stable economic environment where both inflation and unemployment remain low. Jerome Powell’s job is not easy, and the path forward will likely have its challenges. But so far, the Fed has navigated these complexities with a steady hand.As your financial advisor, our goal is to help you understand these developments and how they impact your financial plan. We’ll continue to monitor the economy, markets, and rates closely, and we’re here to address any questions or concerns you may have. Together, we’ll navigate these changing times and keep your financial goals on track.