The much-awaited Fed pivot is finally on the horizon. Last Friday, Federal Reserve Chairman Jerome Powell said in his speech at the famous annual Jackson Hole Economic Symposium that ‘the time has come to adjust policy’, clearly indicating a rate cut in the US at the upcoming FOMC meeting in September. Stock and bond markets rejoiced, as they have always done in the past.
In the past 25 years, the US has had three rate-cutting cycles and the initial reaction on the eve of the first such action has always been positive. But how has the follow-up action been as the rate-cutting cycle continues? Here are some insights on how various asset classes and key macro metrics have performed during past rate-cutting cycles (see table also) and takeaways for investors. For this analysis, we have considered changes from the month of the first rate-cut to the month of the last rate-cut in the cycle.
An analysis of the events since the beginning of the interest rate cutting cycle gives the message that one needs to be careful about what one wishes for (low interest rates).
glass half full?
When a cycle of interest rate cuts begins, the battle is only half won. Victory over inflation can be declared only when a moderation in the economy is confirmed, which will become clear sometime next year.
The last three times the Fed cut rates, the US economy eventually ended in recession. Even in 2020, when the recession caused by the Covid-19 pandemic began, the economy was already showing signs of a slowdown. In earlier cycles, too, several rate-cutting cycles ended in recession. Soft landings have been rare, but were achieved once during a cycle in the mid-1990s.
Each cycle had slightly different dynamics. In 2000, the economy/markets had already started weakening/improving before the rate cut, while in 2007 both continued strengthening/rising for a few months even after the rate cut, the end result being that the economy/markets faced painful times at different periods during past rate-cutting cycles.
During the 2001-03 rate-cut cycle, the Dow Jones, S&P500 and Nasdaq Composite declined 17, 32 and 34 per cent, respectively, while the Nifty50 outperformed by declining 10 per cent. While in India, too, the slowdown during that cycle was severe, the recovery phase began as early as 2003. In contrast, the pain continued even after all four indices declined 30-40 per cent by the time of the last rate cut in the September 2007 to December 2008 rate-cut cycle.
Gold has been the outperformer in these cycles, delivering strong returns in dollar terms and becoming even stronger following the depreciation in the Indian Rupee (USDINR) in the 2007-08 and 2019-20 cycles.
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Also read: US Fed keeps interest rates steady, expects just one cut in 2024
How should investors position themselves?
The possibility of a soft landing remains, but investors now have to assume it’s not a certainty.
Given this, some hedging of the portfolio by increasing exposure to gold and fixed income could be a good move. Also, investors need to closely monitor the trend in the unemployment rate in the US over the next few months. When investors try to analyse why rate-cutting cycles have been bad for the markets overall, one should examine the data to see what factors drive rate cuts.
Rising unemployment rates are a factor that influences the start of a rate cutting cycle as the US Fed attempts to balance its dual mandate of price stability and maximum employment. This is the case this time as well, with the July unemployment report triggering the Sahm Rule recession indicator. When unemployment rises, spending in the consumption-driven US economy is affected, triggering a recession/slowdown, which has ramifications for economies and markets around the world.
