If all goes as expected, the Federal Reserve will cut interest rates for the first time since the outbreak of the COVID-19 pandemic in less than a week, a move that is widely expected and whose impact is likely to linger in the market for some time.
Conventional wisdom holds that stocks generally do well after rate cuts. The Fed stimulates spending by businesses and consumers by lowering borrowing costs, which is good for stocks.
But strategists say investors looking for a rate-cutting cycle playbook should take a more nuanced view, especially in today’s unusual environment, with the U.S. economy still unwinding pandemic-era distortions and dominated by high-flying technology stocks. “Every cycle is different,” said Jeff Buchbinder, chief equity strategist at LPL Financial.
The last four major rate-cutting cycles show why it’s hard to draw broad conclusions. Market performance after a new easing cycle begins can vary widely. The Morningstar U.S. Market Index rose more than 21% in the 12 months after the Fed began cutting rates in 1995 as the economy pulled off a rare soft landing. But returns fell more than 10% after the dot-com bubble burst in 2001 and the Fed began cutting rates.
“A lot of investors think there’s some kind of Fed rate-cutting playbook, but there isn’t,” said Denise Chisholm, head of quantitative market strategy at Fidelity Investments.
The reasons for the rate cut are important
Behind these very different years are different market fundamentals and the Fed’s attitude. If the market perceives that the Fed is confident and in control of achieving a soft landing, the market will react differently than if it believes that the Fed is reacting to the threat of a recession by cutting rates.
To understand what's likely to happen in the year ahead, "you need to think about why the Fed is cutting rates," said Lara Castleton, head of portfolio construction and strategy at Janus Henderson Investors.
Chisholm said there are limited historical examples to draw on. Going back to the 1960s, there aren’t many examples, “so you don’t have a lot of robust data to make an assessment.”
Chisholm explained that about half of the time, the Fed initiated easing because it believed the economy was heading for a recession. In other cases, it lowered rates to recalibrate monetary policy rather than respond to economic threats, which some call "maintenance cuts."
Be prepared for volatility
As is always the case, no one can predict the market. Even amid encouraging data, U.S. stocks remain driven by sentiment.
“Even if the Fed begins its rate-cutting cycle, the market will still be concerned,” Buchbinder said. After two weaker-than-expected jobs reports, investors are struggling to determine whether the Fed waited too long to cut rates and thereby opened the door to a recession.
Buchbinder added that much of the upside from the upcoming rate cut cycle has already been factored into the U.S. stock market, which has risen more than 24% over the past 12 months. "The market has already benefited from the upcoming rate cuts, so further gains may be limited," he said. But on the other hand, a true soft landing for the economy could give U.S. stocks more room to rise.
It’s not immediately clear which scenario will play out in the short term. Buchbinder expects the market to debate it in the coming months. “That’s why you see volatility around these turning points and policy changes, they just add to the uncertainty,” he said.
Article forwarded from: Jinshi Data
