Impact of Fed rate cuts

The impact of Fed rate cuts is already upon us, with stocks rising and the 30-year mortgage rate dropping from 7% in July to 6.2%.

The Fed stole the limelight with its decision in September to lower the benchmark interest rate to a target range between 4.75% and 5.00%.

Market watchers on the consensus side of a 25 basis points cut believe the Fed 50 basis points cut was aggressive.

But the contrary could be true. 

“The Fed’s monetary loosening cycle with its recent 50 basis points cut, taking the Fed fund rates to 4.75% to 5.00% range, is still in restrictive territory,” Darren Winters wrote in a piece entitled, Monetary Loosening Cycle, dated September. 

“If the Fed fund rates drop from 2.75 per cent to 3 per cent, in 2026, is considered a neutral monetary policy stance, which neither encourages nor discourages economic activity,” Darren Winters added. 

Impact of Fed rate cuts

So, in reality, by keeping the Fed fund rates between 4.75% and 5.00% the Fed is maintaining a tight monetary policy and saying that it has pivoted to loosening policy is not entirely accurate.

The current Fed fund rate of 4.75% and 5.00% is still restrictive.    

But despite the Fed maintaining a restive policy, the 50 basis points is already impacting the speculative rate-sensitive stock market, bonds and the 30-year mortgage rate. 

As noted above, the market knew this was coming, and asset prices have adjusted accordingly.

Stocks and bonds are the most immediately sensitive to the impact of Fed rate cuts with markets operating, efficiently pricing in expected outcomes well before they occur.

So, the impact of Fed rate cuts on stocks most likely began in July, with interest rate-sensitive small-cap stocks experiencing their best single month of performance in two decades.

How do rate cuts impact the S&P 500? 

Historically, the S&P 500 returns 4.9% on average one year after the first interest rate cut, seeing positive returns nearly 70% of the time.

“In the three months following a rate cut, the market often dips but typically rebounds by the six-month mark.

That aligns with conventional wisdom that lower interest rates stimulate economic activity by reducing borrowing costs for businesses and consumers, which tends to benefit the stock market,” wrote Visual Capitalist.

The highly leveraged real estate market is also sensitive to the Fed fund rate fluctuations through mortgage rate changes dropping to 6.2%

The lower the 30-year mortgage rate drops, the more affordable it is for the next generation of first-time home buyers.  

The bond market is also impacted by Fed rate cuts

The 10-year treasury yields, the benchmark for setting interest rates for business loans, auto loans, and mortgages, fell on news of a Fed 50 basis point cut.

The 10-year Treasury yield, at 4.4% in July, now hovers at 3.7% and is near their 52-week lows.

Pimco Chief Investment Officer Dan Ivascyn discussed the impact of Fed rate cuts and was blunt in his assessment of what it means, stating:

“If you have a three-to-five-year time horizon, this is noise,” while adding, “It’s less important than people think it is,” he said. 

Most of the companies in the S&P 500 are protected from rising rates because they are locked in lower rates in 2020 and 2021 and, and many loans are up for renewal in 2025. 

Following the rate-cutting cycles, most S&P 500 returns tend to be positive, and these dynamics may present a unique scenario for multinationals. 

Moreover, in light of deteriorating geopolitics and multi-front wars, lower interest rates support the policy to manufacture at home,

Manufacturing, a capital-intensive low-profit margin sector, benefits from lower Fed fund rates, because it filters down to lower business loan rates. Fed rate cuts also impact refinancing risks, making refinancing deals less risky. 

Historic impact of Fed rate cuts

PinPoint Macro Analytics shows S&P 500 performance after interest rate cuts since 1973.

The S&P 500 has performed well after the first rate cut over the last five decades.

Historically, the S&P 500 returns 4.9% on average one year after the first interest rate cut, seeing positive returns nearly 70% of the time.

During the first three months following a rate cut, the market often dips but typically rebounds by the six-month mark.

However, the impact of a Fed rate cut during a presidential election cycle could be bullish for stocks, thereby spurring a potential cyclical bull market in stocks

This aligns with conventional wisdom that lower interest rates stimulate economic activity by reducing borrowing costs for businesses and consumers, which tends to benefit the stock market.

Before you go all in, the impact of Fed rate cuts is no guarantee of a stock bull market

S&P 500 performance following rate cut cycles can and has also varied significantly. For instance, US equities saw double-digit declines after the first rate cuts in 1973, 1981, 2001, and 2007. 

All the same, the S&P 500 surged 36.5% one year after the 1982 rate cut cycle. The anomaly is that in 1982, the US election was held in November.  In the most recent rate-cut cycle, the S&P 500 jumped by 14.5%, in the following year.

In this way, interest rate cuts don’t show the whole picture. Instead, positive earnings growth may offer a more reliable indicator of S&P 500 performance in the following year. When earnings growth is positive, the market averages 14% returns one year later. In contrast, when earnings decline during periods of falling interest rates, the S&P 500 increased by 7%, on average.

The takeaway from the impact of Fed rate cuts, a monster stock rally usually follows if it is combined with an election year

But don’t take that to the bank, if you survived playing this game long enough you’ll realise that the laws of physics don’t apply, certainty is a fantasy, particularly when the game is rigged.

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