On 18th September 2024, the U.S. Federal Reserve (“Fed”) cut the target range for the federal funds rate by 0.5%. This lowering of the benchmark U.S. interest rate represented the first cut since March 2020, when the Fed cut rates in response to the Covid-19 pandemic. The September 2024 cut marked the start of the Fed’s rate cutting cycle and was followed by another 0.25% cut in their November meeting.
The Fed pursues a dual mandate to promote maximum employment and price stability i.e. low unemployment and inflation not exceeding 2%. Inflation exceeded 9% during mid-2022, which led the Fed on an aggressive rate hiking regime where they increased rates to their highest level in over 20 years. With inflation having slowly cooled over the last year, the Fed is now at a place where they can embark upon a rate cutting cycle. As of now, market expectations are of 1-2% in cuts over 2025, with the probability of a 0.25% cut in December at roughly 62%.
A basic concept to grasp is that interest rates are the price of money, thus raising rates makes money more expensive, while cutting rates makes money cheaper. The recent rate cutting environment has two major stimulative effects: (i) the market can borrow money more cheaply and the cost of existing debt is cheaper; (ii) as the government risk-free rate is lower, market participants have to look at other assets to increase their rate of return.
Other than interest rates, there are various other major economic variables to consider. These include inflation, unemployment, broader monetary policy, corporate earnings, regulatory landscape, and geopolitical stability.
Interest rates in the U.S. have structurally declined over the last 50 years, from the 8-10% of the 1980s, to the 0% era of the 2010s, to the recent 5%+ environment.
Using the S&P 500 as a gauge for U.S. equities, we can observe that it has generally risen following interest rate cuts (on a 3-month, 6-month, and 1-year time horizon). There have been a few exceptions, notably during periods when the U.S. economy was in recession. However, these were only short-run deviations from a structural rise in U.S. equities over the last 50 years.
Commodities and interest rates have a more complex relationship, with impact via the cost of inventories, the lack of yield on commodities, and exchange rate considerations (given many major commodities are priced in US$). The link between commodities and inflation is more pronounced and they are often seen as a leading indicator for inflation. Commodities are also commonly used as inflation hedges.
Fixed income instruments like bonds have a very clear inverse relationship with interest rates, whereby bond prices fall as interest rates rise.
Crypto has only been involved in two sets of rate cuts (prior to 2024). Absent short-term variation, crypto has performed extremely well after cuts, particularly on a 12-month time horizon, recording 537% growth one year after the March 2020 cut.
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