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Traders are drawing parallels to 1995, when Alan Greenspan and the Federal Reserve successfully orchestrated a rare soft landing for the economy. As the Fed approaches its first interest-rate cut in four years, market participants are keenly observing which policy approach—25 basis points or 50 basis points—might be most advantageous for the US economy.
Historically, the anticipation of such policy adjustments has led to rallies in both bonds and stocks. Currently, the critical decision for Chair Jerome Powell involves choosing the most effective rate reduction strategy. Kristina Hooper, Chief Global Market Strategist at Invesco, suggests that the US economy is well-positioned to avoid a recession as the Fed begins easing its policy ahead of the upcoming US election. According to Hooper, “Once the Fed starts to cut, there’ll be a psychological reaction to that,” which could offer support to the market.
Analysis indicates that the S&P 500 Index, Treasuries, and gold have generally performed well when the Fed begins lowering rates. Historical data from the past six Fed easing cycles, dating back to 1989, reveal that the S&P 500 Index has averaged a 13% increase in the six months following the initiation of rate cuts, with exceptions during recessionary periods in 2001 and 2007.
In addition, short-term Treasuries have typically outperformed longer-term notes during these cycles. This phenomenon, known as yield curve steepening, has resulted in the 10-year and two-year yield gap widening by an average of 44 basis points six months after the initial cut. Gold, often seen as a hedge against economic uncertainty, has delivered positive returns during four out of the past six Fed easing cycles. Meanwhile, the performance of the dollar and oil has been mixed.
The election introduces additional uncertainty, with starkly different economic agendas proposed by the candidates. Republican nominee Donald Trump has pledged to impose substantial tariffs and extend tax cuts, measures perceived to be favorable for the dollar but potentially detrimental to bonds. Conversely, Democratic candidate Kamala Harris has proposed increasing the corporate tax rate, which could impact corporate earnings.
Salman Ahmed, Global Head of Macro and Strategic Asset Allocation at Fidelity International (TSXV:FMN), acknowledges the likelihood of a soft landing but notes that election outcomes could significantly influence market conditions. Ahmed has adjusted his rating of US equities to neutral from overweight, partially due to the uncertainties associated with the election.
As the Fed's policy shift unfolds and the election approaches, market participants, including major financial institutions like Goldman Sachs, will continue to monitor these developments closely. Reflecting on past cycles can provide valuable insights into potential future impacts, guiding strategies in an evolving economic landscape.
