The Fed's move seems familiar? Traders flip back to the 1995 script

As the Federal Reserve is about to cut interest rates for the first time in four years, traders are reviewing the rare soft landing achieved by Alan Greenspan leading the Fed in 1995 to formulate current trading strategies.

Like nearly thirty years ago, US Treasuries and US stocks are rising ahead of the key Federal Reserve meeting. But this time, the core issue facing Fed Chair Powell is: which way - a 25 basis point cut or a 50 basis point cut - is most beneficial for the US economy.

According to Kristina Hooper, Chief Global Market Strategist at Invesco, as the Fed begins to ease policy ahead of the US election, the US economy seems poised to avoid a recession.

She said, "Once the Fed starts cutting rates, it will trigger a psychological response, which will be a positive factor."

Based on Bloomberg's analysis of the six easing cycles by the Fed since 1989, the S&P 500 Index, US Treasuries, and gold typically rise when the Fed starts cutting rates.

Data shows that in terms of the stock market, the S&P 500 Index has on average risen by 13% in the six months following the Fed's rate cuts, excluding the economic recessions of 2001 and 2007.

Meanwhile, during Fed easing cycles, short-term US Treasuries typically outperform long-term Treasuries, a phenomenon known as steepening of the yield curve. In the six months after the Fed's first rate cut, the yield spread between US 10-year and 2-year Treasuries typically widens by an average of 44 basis points.

Additionally, in four out of the Fed's past six easing cycles, gold has brought returns to investors. The US dollar and oil, on the other hand, have seen mixed movements.

Of course, traders are far from certain about the economic outlook for the coming months.

The Fed is set to cut rates before the confrontation between former President Trump and Vice President Harris in the November election. Both presidential candidates have very different economic agendas, but depending on the outcome of the congressional vote, both could potentially disrupt global markets.

Salman Ahmed, Global Head of Macro and Strategic Asset Allocation at Fidelity International, said, "A soft landing is the most likely scenario. But the election will be crucial, and this could be a unique cycle." He has downgraded his rating on US stocks from overweight to neutral, partly due to election risks.

Republican candidate Trump has pledged to impose high tariffs and extend tax cuts, a policy mix seen as favorable for the US dollar and unfavorable for bonds. Economists at Goldman Sachs suggest that Trump's tariff policy, if implemented, could fuel inflation.

The former president has promised to reduce the corporate tax rate from 21% to 15%, which would benefit corporate profits. In contrast, his Democratic opponent Harris proposes raising the rate to 28%, which according to Goldman economists, would reduce corporate earnings by about 5%

A Replay of the 1995 Script?

In the past six easing cycles since 1989, the Federal Reserve has only successfully avoided an economic recession twice - in 1995 and 1998. The US stock and bond markets are expected to achieve a soft landing similar to 1995 this time around.

Back then, Alan Greenspan and his colleagues lowered interest rates from 6% to 5.25% in just six months, preventing the economy from entering a recession. In the 12 months following the initial rate cut, US Treasury yields rose while bond total returns lagged behind cash.

This time, Federal Reserve officials have kept the target range for the benchmark interest rate at 5.25%-5.5% for 14 months, but policymakers have not committed to aggressive rate cuts.

Bond traders expect the Fed to ease by over 200 basis points in the next 12 months, the S&P 500 index is close to its all-time high, and credit spreads are nearing historical lows.

Investors are hopeful of an economic soft landing due to the strong balance sheets of households and businesses. Corporate profits and household wealth are at historical highs, making them less vulnerable to economic shocks.

Yung-Yu Ma, Chief Investment Officer at BMO Wealth Management, stated, "The big problem facing the economy and the stock market is no longer inflation, but high interest rates. By cutting rates now, the Fed may address this issue and prevent an economic downturn."

This has prepared traders for lower borrowing costs and a relatively resilient economy.

The latest stock flow data released by Bank of America and EPFR Global shows funds flowing into the utility and real estate sectors, two key industries closely tied to the economy that have historically benefited from rate cuts as long as economic growth remains robust.

Bloomberg Markets Live strategist Tatiana Darie also pointed out that traditionally, US Treasuries tend to rally at the start of a Fed easing cycle, typically coinciding with economic weakness. However, in the case of a soft landing, bond performance often lags behind stocks