The performance of stocks, bonds, and the dollar following a Federal Reserve rate-cutting cycle largely hinges on the state of the U.S. economy. With the Federal Reserve set to initiate a series of rate cuts, investor sentiment and market reactions may depend on one critical question: will the Fed's actions come in time to prevent a potential economic downturn?
The Federal Reserve’s Upcoming Rate Cuts
On Wednesday, the Federal Reserve is expected to begin lowering borrowing costs, following a prolonged period of raising interest rates to their highest level in over two decades. Market expectations are for a total of 250 basis points of easing by the end of 2025, according to data from LSEG. This has raised crucial questions for investors, including whether the Fed's cuts will be enough to stave off a looming recession.
In past cycles, the S&P 500, a benchmark for U.S. stock performance, has reacted differently depending on the broader economic context. For instance, the index has historically slumped by an average of 4% in the six months following the Fed’s first rate cut if the economy was already in recession, according to data from Evercore ISI. In contrast, the S&P 500 has risen by an average of 14% when rate cuts occurred during periods of economic growth. With the index up 18% in 2024, much of its future trajectory depends on whether the economy slides into recession or avoids it.
Stock Market Performance: Recession vs. No Recession
The economy’s condition at the time of rate cuts is pivotal for how stocks will perform in the months and years following. Historically, if rate cuts coincide with a recession, they have not provided enough support to offset declines in corporate profits, uncertainty, and lack of confidence in the market.
“If the economy is falling into recession, the rate cuts aren’t enough of a support to offset the move down in corporate profits and the high degree of uncertainty and lack of confidence,” says Keith Lerner, co-chief investment officer at Truist Advisory Services.
Despite concerns, the current state of the U.S. economy has so far not shown definitive signs of recession. Economists, for now, see little evidence that a recession is already underway. If this trend holds, it bodes well for U.S. equities, potentially driving further gains.
"Based on previous easing cycles, our expectation for aggressive rate cuts and no recession would be consistent with strong returns from U.S. equities," says James Reilly, senior market analyst at Capital Economics.
However, the last few weeks have seen volatility in asset prices, reflecting investors' concerns about the economy. Weakness in the labor market has led to sharp swings in the S&P 500, while global growth worries have contributed to falling commodity prices, including Brent crude oil, which is now trading near its lowest level since late 2021.
The Recession Factor and Its Impact on Stocks
When the Federal Reserve initiates rate cuts, stocks typically fare better if those cuts are not accompanied by a recession. Data from Ryan Detrick, chief market strategist at Carson Group, shows that the S&P 500 tends to decline by an average of nearly 12% one year after an initial rate cut during a recession. On the other hand, during periods of economic growth, when rate cuts are aimed at normalizing policy rather than responding to economic distress, the S&P 500 averages a gain of 13%.
"The linchpin to the whole thing is that the economy avoids recession," says Michael Arone, chief investment strategist for State Street Global Advisors.
The S&P 500 has historically dipped leading into a rate cut and then risen in the months that followed. Evercore data indicates that, on average, the S&P 500 rises by 6.6% one year after the first rate cut, although this figure is slightly below the index’s long-term annual average since 1970.
Among various sectors, consumer staples and consumer discretionary tend to perform the best following a rate cut, each rising about 14% over the subsequent year. Healthcare stocks have historically gained 12%, while the technology sector has seen an 8% increase, Evercore’s data shows. Small-cap stocks, known for their sensitivity to economic shifts, have also performed well, with the Russell 2000 index rising 7.4% in the year following the first cut.
Bonds: A Safe Haven During Economic Uncertainty
Bonds, particularly U.S. Treasuries, have historically been a favored investment during rate-cutting cycles, especially in recessionary periods. Investors often seek the safety of government bonds during times of economic uncertainty, leading to falling yields and rising bond prices.
Treasury yields, which move inversely to bond prices, typically decline when the Fed cuts rates, reflecting a flight to safety. Data from Citi strategists indicates that the Bloomberg U.S. Treasury Index returned a median of 6.9% in the 12 months following the first rate cut. However, in instances of a "soft landing," where the economy slows but avoids a recession, returns have been more modest, at 2.3%.
Yields on the benchmark 10-year Treasury have already fallen by about 20 basis points this year, reaching their lowest level since mid-2023. Despite this, further gains for Treasuries may be less certain without a significant economic downturn that forces the Fed to cut rates more aggressively.
“If you get a hard landing, yes, there’s a lot of money on the table,” says Dirk Willer, Citi’s global head of macro and asset allocation strategy. “If it’s a soft landing, it’s really a bit unclear.”
Historically, the 10-year Treasury yield has fallen by a median of nine basis points in the month following the first cut during the last 10 easing cycles, before climbing by 59 basis points over the next year, as investors begin to price in an economic recovery, according to data from CreditSights.
The Dollar’s Response to Rate Cuts
The U.S. dollar's performance following a rate-cut cycle depends largely on the state of the U.S. economy and the actions of other central banks around the world. In times of recession, the Fed is often forced to implement deeper cuts, which can diminish the dollar’s appeal to yield-seeking investors.
Goldman Sachs' analysis of the last 10 rate-cut cycles found that the dollar strengthened by a median of 7.7% against a trade-weighted basket of currencies a year after the first cut when the U.S. economy was not in recession. When the U.S. economy was in a downturn, however, the dollar gained only 1.8%.
The dollar tends to outperform other currencies when the Fed’s rate cuts coincide with those of other central banks. This dynamic appears to be in play now, with the European Central Bank, Bank of England, and Swiss National Bank also lowering rates. Despite this, the U.S. dollar index, which measures the greenback’s strength against a basket of currencies, has weakened since June, though it remains up about 9% over the past three years.
"U.S. growth still stands out a little bit better than most countries," says Yung-Yu Ma, chief investment officer at BMO Wealth Management. "Even though the dollar strengthened so much, we wouldn’t expect a meaningful degree of dollar weakness."
However, should U.S. growth falter, the dollar could be vulnerable. Analysts at BNP Paribas suggest that the Fed may need to cut rates more than other central banks in a recession scenario, further reducing the dollar’s yield advantage and weakening its value.
The Federal Reserve's rate cuts are likely to have varying impacts on the stock market, bond market, and U.S. dollar depending on the health of the U.S. economy. While past data suggests that stocks and bonds can perform well if the economy avoids a recession, the future remains uncertain. Investors will be watching closely to see how the Fed's actions influence economic growth and whether they are enough to avert a downturn.
(Source:www.reuters.com)
The Federal Reserve’s Upcoming Rate Cuts
On Wednesday, the Federal Reserve is expected to begin lowering borrowing costs, following a prolonged period of raising interest rates to their highest level in over two decades. Market expectations are for a total of 250 basis points of easing by the end of 2025, according to data from LSEG. This has raised crucial questions for investors, including whether the Fed's cuts will be enough to stave off a looming recession.
In past cycles, the S&P 500, a benchmark for U.S. stock performance, has reacted differently depending on the broader economic context. For instance, the index has historically slumped by an average of 4% in the six months following the Fed’s first rate cut if the economy was already in recession, according to data from Evercore ISI. In contrast, the S&P 500 has risen by an average of 14% when rate cuts occurred during periods of economic growth. With the index up 18% in 2024, much of its future trajectory depends on whether the economy slides into recession or avoids it.
Stock Market Performance: Recession vs. No Recession
The economy’s condition at the time of rate cuts is pivotal for how stocks will perform in the months and years following. Historically, if rate cuts coincide with a recession, they have not provided enough support to offset declines in corporate profits, uncertainty, and lack of confidence in the market.
“If the economy is falling into recession, the rate cuts aren’t enough of a support to offset the move down in corporate profits and the high degree of uncertainty and lack of confidence,” says Keith Lerner, co-chief investment officer at Truist Advisory Services.
Despite concerns, the current state of the U.S. economy has so far not shown definitive signs of recession. Economists, for now, see little evidence that a recession is already underway. If this trend holds, it bodes well for U.S. equities, potentially driving further gains.
"Based on previous easing cycles, our expectation for aggressive rate cuts and no recession would be consistent with strong returns from U.S. equities," says James Reilly, senior market analyst at Capital Economics.
However, the last few weeks have seen volatility in asset prices, reflecting investors' concerns about the economy. Weakness in the labor market has led to sharp swings in the S&P 500, while global growth worries have contributed to falling commodity prices, including Brent crude oil, which is now trading near its lowest level since late 2021.
The Recession Factor and Its Impact on Stocks
When the Federal Reserve initiates rate cuts, stocks typically fare better if those cuts are not accompanied by a recession. Data from Ryan Detrick, chief market strategist at Carson Group, shows that the S&P 500 tends to decline by an average of nearly 12% one year after an initial rate cut during a recession. On the other hand, during periods of economic growth, when rate cuts are aimed at normalizing policy rather than responding to economic distress, the S&P 500 averages a gain of 13%.
"The linchpin to the whole thing is that the economy avoids recession," says Michael Arone, chief investment strategist for State Street Global Advisors.
The S&P 500 has historically dipped leading into a rate cut and then risen in the months that followed. Evercore data indicates that, on average, the S&P 500 rises by 6.6% one year after the first rate cut, although this figure is slightly below the index’s long-term annual average since 1970.
Among various sectors, consumer staples and consumer discretionary tend to perform the best following a rate cut, each rising about 14% over the subsequent year. Healthcare stocks have historically gained 12%, while the technology sector has seen an 8% increase, Evercore’s data shows. Small-cap stocks, known for their sensitivity to economic shifts, have also performed well, with the Russell 2000 index rising 7.4% in the year following the first cut.
Bonds: A Safe Haven During Economic Uncertainty
Bonds, particularly U.S. Treasuries, have historically been a favored investment during rate-cutting cycles, especially in recessionary periods. Investors often seek the safety of government bonds during times of economic uncertainty, leading to falling yields and rising bond prices.
Treasury yields, which move inversely to bond prices, typically decline when the Fed cuts rates, reflecting a flight to safety. Data from Citi strategists indicates that the Bloomberg U.S. Treasury Index returned a median of 6.9% in the 12 months following the first rate cut. However, in instances of a "soft landing," where the economy slows but avoids a recession, returns have been more modest, at 2.3%.
Yields on the benchmark 10-year Treasury have already fallen by about 20 basis points this year, reaching their lowest level since mid-2023. Despite this, further gains for Treasuries may be less certain without a significant economic downturn that forces the Fed to cut rates more aggressively.
“If you get a hard landing, yes, there’s a lot of money on the table,” says Dirk Willer, Citi’s global head of macro and asset allocation strategy. “If it’s a soft landing, it’s really a bit unclear.”
Historically, the 10-year Treasury yield has fallen by a median of nine basis points in the month following the first cut during the last 10 easing cycles, before climbing by 59 basis points over the next year, as investors begin to price in an economic recovery, according to data from CreditSights.
The Dollar’s Response to Rate Cuts
The U.S. dollar's performance following a rate-cut cycle depends largely on the state of the U.S. economy and the actions of other central banks around the world. In times of recession, the Fed is often forced to implement deeper cuts, which can diminish the dollar’s appeal to yield-seeking investors.
Goldman Sachs' analysis of the last 10 rate-cut cycles found that the dollar strengthened by a median of 7.7% against a trade-weighted basket of currencies a year after the first cut when the U.S. economy was not in recession. When the U.S. economy was in a downturn, however, the dollar gained only 1.8%.
The dollar tends to outperform other currencies when the Fed’s rate cuts coincide with those of other central banks. This dynamic appears to be in play now, with the European Central Bank, Bank of England, and Swiss National Bank also lowering rates. Despite this, the U.S. dollar index, which measures the greenback’s strength against a basket of currencies, has weakened since June, though it remains up about 9% over the past three years.
"U.S. growth still stands out a little bit better than most countries," says Yung-Yu Ma, chief investment officer at BMO Wealth Management. "Even though the dollar strengthened so much, we wouldn’t expect a meaningful degree of dollar weakness."
However, should U.S. growth falter, the dollar could be vulnerable. Analysts at BNP Paribas suggest that the Fed may need to cut rates more than other central banks in a recession scenario, further reducing the dollar’s yield advantage and weakening its value.
The Federal Reserve's rate cuts are likely to have varying impacts on the stock market, bond market, and U.S. dollar depending on the health of the U.S. economy. While past data suggests that stocks and bonds can perform well if the economy avoids a recession, the future remains uncertain. Investors will be watching closely to see how the Fed's actions influence economic growth and whether they are enough to avert a downturn.
(Source:www.reuters.com)
