The recent interest rate cut by the US Federal Reserve was eagerly expected by companies and investors alike. Tight economic conditions for an extended period sparked the fear that the US economy might go toward a recession and generated nervousness in the financial markets.
But the 0.5% rate cut showed the markets that the Fed is decisive in taking measures to prevent this and now the market expects another 1% cut by the end of the year. eToro analyst for Romania, Bogdan Maioreanu notes that the ECB has cut rates twice in the last three months and is already on the path to more interest rate cuts this year as new data is showing a weakness in the European economy. The decrease in interest rates will stimulate some sectors and will help the economy to go into a growth path.
During periods of economic slowdown, the central banks often cut the key interest rate to stimulate financial activity. Lower interest rates are generally considered growth catalysts, making borrowing cheaper for consumers and businesses. This will stimulate both the consumption and investments. While in the EU consumption is around 53% in the United States this percentage is almost 68% of the GDP.
As a result lower rates may lead to increased borrowing, a boost in investments, higher corporate profits, more robust economic growth, and rising stock prices. Also, the rate cuts in the US are also positively impacting companies in other regions. For example, in Europe, most DAX companies generate only a small portion of their revenue in Germany. For the top five performing stocks, the average domestic revenue share is 26.8%.
The consumer discretionary sector tends to perform well in low-interest-rate environments as slower rates reduce borrowing costs, making it easier for consumers to finance big-ticket items like cars, electronics, white goods and vacations. With more disposable income and cheaper credit, consumer spending typically increases, driving higher revenues and profits for companies in this sector. However it will take some time for the sector to grow as effects of the rate cuts are not immediate.
Another sector that thrives in a low interest rate environment is technology. While in the past year this sector, especially through its “magnificent seven“ stocks (Apple, Microsoft, Google parent Alphabet, Amazon, Nvidia, Meta Platforms and Tesla), was the one that took the US stock market to new heights, interest rate cuts should also benefit high-growth companies. The reason is that these companies need a lot of cash to grow most likely from loans and lower interest rates will decrease the costs and shorten their road to profitability. Also small cap companies often benefit from rate cuts, as lower borrowing costs help them raise capital for new projects and reduce costs for debt servicing. Meanwhile, companies that are rich in cash might see their financial gains decrease.
The real estate sector benefits significantly from low interest rates because cheaper borrowing costs make it more affordable for consumers and businesses to finance property purchases. This also stimulates the construction and material sectors. In the US there’s currently a shortage of about 4 million homes, according to the National Association of Realtors’ most recent projections. This imbalance is likely to drive prices up in some regions. Moreover, lower interest rates will stimulate the investments in new construction projects and may lead to increased consumption in materials.
However, the benefits of interest rate cuts will not show immediately in the economy. Other external factors like the geo-political situation, increases in customs tariffs for imports of some goods may influence how different sectors will perform in the next period. But for investors, interest rate cuts are a long awaited event and they were preparing for it. According to the latest eToro Retail Investor Beat survey, at end of Q2, 69% of global, 79% of Czechs, 76% of US, and 75% of Romanian individual investors were having cash in their portfolios ready to go in search of low priced companies that suffered during the high interest rate period but ready now to take advantage of lower financing costs.
