By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
In September, the Federal Open Market Committee chose to cut rates by 50bps, signaling the beginning of a rate-cutting cycle that is expected to continue through the end of next year. Of course, those expectations could change quickly as election results and new economic data come in. Rates were cut with the assumption that inflation has been tamed, but a resurgence in inflationary forces could lead the Fed to pause or potentially hike again. Or, if the economy starts heading towards recession, they may accelerate their accommodation.
Assuming the easing cycle continues, the history of how falling rates have affected investments, business activity, consumption, and inflation is mixed and highly dependent on why the cuts were initiated. For example, in the case of the stock market, the S&P 500 has tended to have positive returns through rate cutting cycles, except for when the Fed cut to fight a recession (see chart below). However, in most cases the market saw a notable drawdown within a year of the cut, even if it went on to recover.
Bonds across the credit and duration spectrum also tend to perform well after rate cuts begin, both in the case of a recession and a soft landing. A trend to watch will be how much of the $6.3 trillion in money market funds flows out into equities or longer duration bonds as rates fall, but historically flows have not reversed out of money markets until rates hit around 3%.
The most obvious goal of lowering rates is to stimulate economic growth, enabling businesses to transact and finance projects with more favorable terms. It should theoretically benefit small businesses even more since they are more likely to use floating rate loans, which should revive the currently low level of optimism (see chart below). The economy as a whole has not cooled that much, however, with significant support coming from a solid labor market. This might make the benefits of cuts less dramatic than when they take place during times of economic turmoil. 
On the consumer side, spending growth tends to pick up during easing cycles, with the exception of the COVID-19 pandemic and the global financial crisis. Housing costs, however, do not always benefit as much as expected for being so rate-sensitive. One reason is that 30-year mortgage rates tend to follow the 10-Year Treasury Rate more closely, and both have risen so far since the September cut. The spread between mortgage and treasury rates has also widened significantly in the last few years. Even though this spread could narrow back to typical levels before long, we doubt that mortgage rates will come down significantly as the yield curve normalizes.
Historically, inflation has fallen during rate cut cycles, which is not surprising given that the Fed usually makes cuts when economic growth is slowing. However, it often picks back up after the cycle ends, and in today’s case we are especially concerned about a second wave of inflation in the next few years given factors like deglobalization, demographic shits, and the seemingly bipartisan desire to increase the deficit.
Despite all the historical precedent for rate cut regimes, history never repeats itself exactly. There is still a high degree of uncertainty in the air, and this business cycle feels unusual given the lingering effects of outsized government intervention.
The S&P 500 returned -0.9% in October and experienced mixed earnings results. The Bloomberg US Aggregate Bond Index fell -2.5% as the 10-Year Treasury Rate rose rapidly from 3.74% to 4.28%.
Charts provided by JP Morgan Chase & Co., Strategas Research Partners, LLC, and YCharts, Inc.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Daniel is a Senior Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.
The Impact of Rate Cuts
By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
In September, the Federal Open Market Committee chose to cut rates by 50bps, signaling the beginning of a rate-cutting cycle that is expected to continue through the end of next year. Of course, those expectations could change quickly as election results and new economic data come in. Rates were cut with the assumption that inflation has been tamed, but a resurgence in inflationary forces could lead the Fed to pause or potentially hike again. Or, if the economy starts heading towards recession, they may accelerate their accommodation.
Assuming the easing cycle continues, the history of how falling rates have affected investments, business activity, consumption, and inflation is mixed and highly dependent on why the cuts were initiated. For example, in the case of the stock market, the S&P 500 has tended to have positive returns through rate cutting cycles, except for when the Fed cut to fight a recession (see chart below). However, in most cases the market saw a notable drawdown within a year of the cut, even if it went on to recover.
Bonds across the credit and duration spectrum also tend to perform well after rate cuts begin, both in the case of a recession and a soft landing. A trend to watch will be how much of the $6.3 trillion in money market funds flows out into equities or longer duration bonds as rates fall, but historically flows have not reversed out of money markets until rates hit around 3%.
The most obvious goal of lowering rates is to stimulate economic growth, enabling businesses to transact and finance projects with more favorable terms. It should theoretically benefit small businesses even more since they are more likely to use floating rate loans, which should revive the currently low level of optimism (see chart below). The economy as a whole has not cooled that much, however, with significant support coming from a solid labor market. This might make the benefits of cuts less dramatic than when they take place during times of economic turmoil.
On the consumer side, spending growth tends to pick up during easing cycles, with the exception of the COVID-19 pandemic and the global financial crisis. Housing costs, however, do not always benefit as much as expected for being so rate-sensitive. One reason is that 30-year mortgage rates tend to follow the 10-Year Treasury Rate more closely, and both have risen so far since the September cut. The spread between mortgage and treasury rates has also widened significantly in the last few years. Even though this spread could narrow back to typical levels before long, we doubt that mortgage rates will come down significantly as the yield curve normalizes.
Historically, inflation has fallen during rate cut cycles, which is not surprising given that the Fed usually makes cuts when economic growth is slowing. However, it often picks back up after the cycle ends, and in today’s case we are especially concerned about a second wave of inflation in the next few years given factors like deglobalization, demographic shits, and the seemingly bipartisan desire to increase the deficit.
Despite all the historical precedent for rate cut regimes, history never repeats itself exactly. There is still a high degree of uncertainty in the air, and this business cycle feels unusual given the lingering effects of outsized government intervention.
The S&P 500 returned -0.9% in October and experienced mixed earnings results. The Bloomberg US Aggregate Bond Index fell -2.5% as the 10-Year Treasury Rate rose rapidly from 3.74% to 4.28%.
Charts provided by JP Morgan Chase & Co., Strategas Research Partners, LLC, and YCharts, Inc.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
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