On September 18, 2024, the Federal Reserve (“the Fed”) may lower interest rates, potentially impacting U.S. Treasury Bonds, Treasury Notes, and the Secured Overnight Financing Rate (SOFR). Let’s discuss how this could affect your finances.
What Happens When the Fed Lowers Interest Rates?
When the Fed lowers interest rates, banks can borrow money more cheaply. This usually leads to lower interest rates on mortgages, car loans, and savings accounts. But it also has a big impact on U.S. Treasury Bonds and Notes.
When you invest in U.S. Treasury Bonds and Notes, you essentially lend money to the government. In return, the government commits to repaying you with added interest in the future. The key distinction between bonds and notes lies in the duration of the loan. Treasury Notes are typically repaid within 2 to 10 years, while Treasury Bonds have a longer term, usually ranging from 20 to 30 years.
What Happens to Bonds When Rates Go Down?
When the Federal Reserve cuts rates, the interest rates on new bonds inevitably decline. However, if you already own a bond with a higher rate, its value increases. Why? Because investors are willing to pay more for a bond that offers a higher return than what’s currently available. Consequently, the prices of existing bonds generally rise.
How Can You Make Money?
Buy Bonds or Bond Futures: If you’re confident that the Fed will continue to lower rates, take action by buying bonds or futures contracts. As bond prices increase, you can sell them for a profit.
Call Options: Another approach is purchasing “call options” on bonds. This provides you with the right, but not the obligation, to buy bonds at a set price in the future. If bond prices surge, your call options could yield substantial returns.
Risks
It is important to consider potential risks. If the Federal Reserve decides to raise rates, bond prices may fall, resulting in possible financial losses. Additionally, unexpected market reactions can lead to increased investor nervousness and a subsequent demand for higher interest rates, which in turn lowers bond prices.
What About the Secured Overnight Financing Rate (SOFR)? SOFR is the rate at which banks lend money to each other overnight. It’s comparable to the interest rate one might receive on a savings account, but it’s specifically used by banks.
What happens to SOFR when rates decrease? If the Fed lowers interest rates, SOFR typically goes down as well, indicating that the overnight borrowing cost becomes cheaper, which is generally beneficial for the economy.
How Can You Make Money?
- SOFR Futures: You can purchase futures contracts based on SOFR. If you anticipate that the rate will decrease, these contracts may become more valuable, allowing you to sell them for a profit.
- 2. Interest Rate Swaps: This is a more complex option, but you could engage in an agreement where you receive a fixed rate while paying the SOFR rate. If SOFR decreases, you could end up paying less, thereby making a profit.
Risks:
- Unexpected Rate Hikes: If the Fed raises rates unexpectedly, SOFR could increase, potentially causing your futures contracts to lose value.
- 2. Market Liquidity: SOFR is a relatively new rate, and trading in this market may not always be easy, which could impact the potential gains or losses.
When the Fed cut rates in past years, bond prices typically went up, and rates like SOFR went down. For example, during the 2008 financial crisis, bond prices soared as the Fed slashed rates to near zero. Investors flocked to bonds because they were seen as safe.
However, every economic situation is different. What happened in the past doesn’t guarantee the same results in the future, so it’s essential to stay informed and consider all the risks.
In summary
If the Fed lowers interest rates on September 18, there are opportunities to make money with U.S. Treasury Bonds, Notes, and SOFR. However, any financial move comes with risks. Understanding the basics can help you make smarter decisions. Remember that the market can be unpredictable. Always consider both the potential rewards and the risks before making a move.
Trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. This matter is intended as a solicitation to trade futures and options.
