What Are the Dangers of Rate Cuts?


As a syndicated columnist for a bank network, Richard’s articles appear weekly on the websites of more than 100 regional and community banks. He has been an editor or contributor on more than a dozen books, including Webvisor, Wealth Exposed, 5 Steps for Selecting the Best Financial Advisor, and The Retirement Bible.




What Are the Dangers of Rate Cuts?
What Are the Dangers of Rate Cuts?


The Federal Reserve Board is always in the news when they’re considering an interest rate change.Sometimes, the Fed raises interest rates in an attempt to curb inflation.

The Federal Reserve Board is always in the news when they’re considering an interest rate change.Sometimes, the Fed raises interest rates in an attempt to curb inflation. Then, eventually, the Fed lowers them again. While a drop in interest rates might seem like a wonderful thing, there are some dangers associated with it, especially if the rate is dropped too suddenly and too much. Let’s look at the downside to rate cuts.

Inflation Could Rise

Typically, when the Fed cuts interest rates, inflation rises. The Fed considers this when deciding on a rate change. That makes timing the rate cut perfectly more crucial. As Reuters reports, the Fed members are concerned that cutting the rate too soon might trigger another rise in inflation.

It works like this. With lower interest rates, consumers can spend more because it’s cheaper to finance products, services, homes, etc. So, consumers go on a buying spree. The more they spend, the greater is the demand for the things they’re buying. As demand goes up, prices also go up. Eventually, inflation becomes a problem, and the Fed has to raise rates again to improve the economy. 

If low rates trigger inflation, what will that mean for you? Even if you’re the most careful spender, inflation will change your life to some degree. Groceries and gas will cost you more. Having maintenance and repairs done on your car or home will be more costly, too. Suddenly, you may decide that the cost of luxuries or even yearly vacations are too much for your budget.

Your Savings Rates Go Down, Too

Don’t forget that when interest rates go down for the country, they also go down at your bank. If you have money in savings or in a CD, you’ll be earning even less interest on it than you are now. For this reason, many people look for a way to invest their money that isn’t so closely tied to the interest rates. 

2% is the target inflation rate that the Federal Reserve seeks to achieve.

Overoptimistic Buyers May Take on Too Much Debt

When interest rates go down, many consumers feel like it’s the perfect time to buy on credit. With low interest rates, the debt will cost them less, right? But the low interest rates won’t last. They never do. So, unless that interest rate is set in stone, there will come a time when that debt starts costing more.And if it’s tied to an asset that’s hard to sell, you might be stuck with the higher costs when inflation starts up again.

In times of low interest rates, many people choose to upgrade to a new or better home. Unfortunately, too many of them don’t consider that that home will be harder to maintain when the rates go back up.If you have borrowed money on an adjustable rate mortgage to save money in the early years of the loan, your interest rate will increase when the rates increase again. Are you prepared to pay your mortgage if it includes a higher rate of interest? 

Other debt that is nearly always affected by interest rates is credit card debt. If you have high balances on your credit cards, you will probably have to pay more in interest when the rates go up. The wise thing to do is to consider the effects of an eventual rate increase before you borrow anything. In short, when interest rates are cut, consumers tend to overspend money they don’t have.

What Happens to the Stock Market?

The US stock market is closely tied to interest rates, too. And companies are just as prone to overspending as consumers. Because the interest rates are so low, it’s easy for them to borrow more to expand. But what happens when the ride is over? What happens when inflation comes back and interest rates go back up? 

Since these companies have expanded, they now have more to sustain. That could mean more employees to pay, more buildings to maintain, and more lines of services and/or products to keep up. Expanding too fast can cause a company to fail. When that happens, your stock certificate isn’t worth anything. Even if the company survives, its stock will drop in value. 

Whenever rate cuts happen, the volatility of the stock market increases dramatically. And that makes the stock market riskier when rates are cut. While rate cuts can help the stock market, the effect is typically less than for gold. 

How Do Rate Cuts Affect Gold?

Do interest rates affect gold prices? Yes, they do, but it’s different than it is for stocks. Gold may fall a bit in the months leading up to a rate cut, but then, it starts increasing. In fact, gold’s average price has almost always increased significantly in the year after a rate cut. According to Forex.com, gold prices average an 11% increase during the year after a rate cut as opposed to just a 7% increase in the Dow Jones and the S&P 500.

One reason the interest rate doesn’t affect gold as directly is that it’s a physical asset. There’s no company out there making decisions that increase the risk of buying gold. It has its own intrinsic value that can’t be wiped away by changes in interest rates. No company is going to get over-excited about the rate cut and expand too much. The asset is always there, just what it is, no more, no less.

Ask the Experts about Safe Haven Gold

Gold is a safe-haven asset that will be valuable in any economic climate. Its performance isn’t tied to the prosperity of any one company. Rate cuts won’t drop the value of the gold you hold, and they’ll likely even increase it. 

Gold will protect the value of your portfolio in good times and bad, in periods of high and low interest rates, and even in times of inflation. If you’d like to know more about investing in a gold IRA, speak to the precious metals specialists at True Gold Republic.

Interested in learning how to buy gold and buy silver?

Call 1-800-300-(GOLD) and speak with a Precious Metals Specialist today!


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