To simplify the complex, theoretically rate hikes should occur in expansionary periods and rate cuts should occur in contractionary periods. In the eyes of the Fed, higher rates can restrict growth and inflation when the economy gets too hot and lower rates can induce growth and inflation when the economy gets too cold. While that framework is probably an oversimplification of the economic cycle, at its core, it likely means that if the Fed is cutting rates, economic activity has slowed.
As of yesterday’s close, the Fed Funds futures market was not pricing in any more rate hikes. With the next FOMC meeting on the docket for next week, we thought it would be helpful to review the directionality of the S&P 500 index following rate cuts from 2001 and 2008.
The S&P 500 index made a new cycle high in March 2000, eight months prior to the first rate cut in January 2001. Between the cycle high and the first rate cut, the index had a rally into the beginning of September 2000 that brought the index to just -0.39% away from matching the cycle high level. Following that bounce, the index declined by 11% into the date of the first rate cut. Despite several bear market bounces along the way, the S&P 500 declined by nearly 50% from peak to trough, with 42% of that decline coming after the date of the first rate cut.
Source: Macrobond.
From June 2006 through September 2007, the Fed hiking cycle was on pause. During that period the S&P 500 moved higher and made a new cycle high on October 9, 2007, a few days after the first cut on September 17, 2007. By December, the economy was in a recession and the Fed cut its target rate from 5.25% to 0.25% over the course of sixteen months. From its cycle high to the end of the cutting cycle, the S&P 500 index declined by more than 55%. Again, there were a few bear market bounces, but the downward trend remained through the cutting cycle.
Source: Macrobond.
Turning to today, the S&P 500 index is roughly 7% below its January 2022 cycle high, despite the +25% rally we have seen since October of last year. Pulling the basic theoretical framework for rate cuts back into view, the Fed Funds futures market is signaling that the Fed is on pause until March 2024, followed by a rate cut in May 2024. While the timing of those expectations may shift around, it is worth highlighting that the S&P 500 has not reached a new high in over twenty months despite several rate hikes, which should be indicative of an expansionary period.
Source: Macrobond.
Source: Bloomberg.
Source: Macrobond.
While we cannot know which direction the Fed will go in their next meeting, it is important to be aware of what rate cuts have historically meant in terms of their view on real economic activity and the impact that view may have had on U.S. equities in the 2001 and 2008 cutting cycles. With that in mind, we will continue to monitor the Fed Funds futures market for changes in expectations and provide updates as more data becomes available.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Economic Analyst
Boyd Watterson Asset Management, LLC