Is the Fed's rate cut a blessing or a curse? The market can only rely on luck
The Federal Reserve is expected to cut interest rates on Thursday, with market expectations for a 50 basis point rate cut exceeding 60%. Analysts point out that the impact of rate cuts depends on the economic environment, and if the rate cut is to address a recession, investors may feel uneasy. Historical data shows that the stock market performance after rate cuts varies, with risks and returns showing binary outcomes. Goepfert suggests observing market performance in the two weeks following the rate cut to assess future investment risks
SentimenTrader's senior research analyst Jason Goepfert stated in a report on Tuesday: "Setting aside opinions, the upcoming rate cut by the Federal Reserve is a gamble for investors. After major rate hike cycles, there is no consistent pattern in the market's future returns."
The Federal Reserve is almost certain to cut rates when it concludes its two-day policy meeting early Thursday Beijing time. More importantly, traders believe there is a greater than 60% chance of a larger 50 basis point rate cut, exceeding the probability of a traditional 25 basis point cut. Meanwhile, the stock market remains relatively flat.
Goepfert noted that investors may recall that the last three times the Fed initiated rate cuts were just before devastating bear markets caused by rate hike cycles. However, there hasn't been a clear pattern before that. Based on the S&P 500 index's distance from multi-year highs at the time of the first rate cut, there was no significant difference in returns.
Investors and analysts emphasize the importance of the environment when discussing the impact of Fed rate cuts on the market. If rate cuts are seen as slowing or preventing an economic downturn, the easing cycle could be a "tailwind" for risk assets like stocks. However, if rate cuts are due to the economy already heading towards a recession and the Fed lagging behind the curve, investors may feel uneasy.
Goepfert is not interested in trying to predict the economic outlook. He wrote, "We don't engage in the illusion that we can know whether this rate cut will occur before an economic recession, although it could greatly impact future returns."
Looking back at history, the impact of rate cuts on the stock market is mixed. Interestingly, Goepfert observed that risks and returns across multiple time frames show quite binary outcomes (see table below) - in the next year, US stocks either "achieve significant returns in low-risk situations, or limited returns in high-risk situations," with no middle ground.
He said, a good rule of thumb is to observe the two weeks following a rate cut, and noted, "If risks outweigh returns, it strongly indicates that next year will be challenging."