Adjusting course in the wake of the Fed's rate pivot

It was nice while it lasted.

In late 2023, reacting to the prospect of a potentially softening economy, the Federal Reserve hinted at multiple rate cuts in 2024. This fueled optimism among borrowers, particularly those eyeing homeownership or refinancing existing mortgages. But persistent inflation coupled with a robust labor market in the ensuing months prompted the Fed to revise its stance. 

Barring an unexpected reversal of trend, this shift potentially eliminates the prospect of rate cuts this year and signals a more cautious approach to future rate adjustments. 

The decreased chance of significant rate drops make sense, but if your client was waiting until rates drop to buy that new house and get in on the American dream, they probably shouldn't hold their breath.

READ MORE: Inflation inched downward in April. What does that mean for wealth management?

Navigating higher borrowing costs

The Fed's revised stance has deflated the hopes of homebuyers who have been able to scrape together the down payment but need a lower interest rate to make their monthly payments affordable. Financial advisors who have taken on the role of financial life coach play a crucial role in guiding clients through the one economic factor that remains constant ─ change. 

Here are key strategies advisors can employ to counsel clients on homeownership and other major purchases in the current environment.

Stress-test affordability. Advisors should conduct thorough affordability assessments with a focus on potential rate hikes — despite the current narrative of eventual interest drops. While there is no shortage of mortgage calculators online, they don't factor in larger life plans, goals, client fantasies and unexpected expenses.

Prioritize debt management. Not all debt is created equal. An advisor can help determine which debt should be paid off first and which will benefit from inflation over time to optimize the client's assets toward homeownership.

READ MORE: 5 tax strategies that pay off in real estate and homeownership

Consider adjustable-rate mortgages (ARMs). While fixed-rate mortgages are a pillar in wealth building and adjustable rate mortgages have been seen as distasteful in the zero interest rate policy — or ZIRP — world, now may be the time to consider this option. However, advisors should carefully explain the potential downsides of ARMs, particularly the risk of future rate adjustments.

Explore alternative housing options. Depending on individual circumstances, exploring alternative housing options like renting or downsizing may be prudent. This will be a hard conversation unless it is broached thoughtfully, since many people are culturally programmed to equate homeownership with achievement and success.

Beyond homeownership

Rates touch every segment of the financial markets. The Fed's intention in raising rates was to discourage borrowing and slow the economy.  

Here are other areas advisors may want to consider. 

Reevaluate fixed income. The paradigm has shifted, and inflation and higher rates may cause traditional fixed income strategies to suffer. We rely on fixed income for noncorrelation, yield and management. Now we only have the yield, and we could see bonds and stocks continue to correlate. Consider investing strategies that seek out opportunities in fixed income. 

READ MORE: Clients want to know: Why buy bonds when 'safe' cash yields 5%?

Review investment strategies. Some advisors did not hear from trusting clients during the quick drops in the markets in 2020 and 2022. As an advisor, have you made sure your clients can tolerate that sort of movement again if it is longer lasting? Check in with your clients and adjust accordingly. 

Remain flexible. While I am not advocating shifting allocations based on the whims of the market, it is important to include opportunity-seeking portions in every portfolio. Design for today's new paradigm, which includes preparing for a market that certain investors may not have experienced before — or seasoned investors may have forgotten could exist — like stocks and bonds correlating.

Navigating constant change: The role of financial advisors

The Fed's recent policy shift in interest rates underscores the laughability of economic forecasting. 

Financial advisors play a vital role in helping clients navigate uncertain markets, particularly when making significant financial decisions like homeownership or other large purchases. The Fed's actions come amid an already cautious investor landscape due to the upcoming elections. This further emphasizes the need for a risk-aware investment strategy with a focus on fundamentals and long-term value creation.

READ MORE: Helping clients cut through the noise of recurrent crises

By providing sound financial guidance, stress testing affordability and reviewing portfolio viability, advisors can empower clients to make informed decisions that align with their long-term financial goals. It is essential that investors proactively understand their financial plan and how market events might impact them before it happens. 

As I talk with advisors almost daily, I'm struck by how crucial it is to remember that the economic landscape will never stop evolving, will never be easy and that the Fed's policy decisions will continue to impact every segment of the markets. By staying informed and adopting a proactive approach, financial advisors can effectively guide clients through the complexities of the current environment, ensuring they are well-positioned to make sound financial choices for the future.