What You Need to Know About First Rate Cuts
The clear message from Wall Street leading up to this week’s long-awaited Fed policy announcement is that interest rate cuts are overwhelmingly bullish. However, a deep dive into historical first rate cuts reveals that they are not universally bullish after hiking cycles. And in today’s high-risk environment, the initial cut could actually be a sign of danger. The table shows all instances of a first Discount Rate cut after a hiking cycle going back to 1914 and the market performance that followed using the Dow Jones Industrial Average (DJIA). To focus on true reversals in monetary policy and avoid anomalies and adjustments, we specifically looked at those cuts coming after two or more rate hikes. While all periods were different, there is a notable and logical relationship. One of the most telling factors for market performance after the Fed starts easing is the gain or loss leading up to the first rate cut. • Periods when the market had fallen -10% or more in the 24 months before the initial cut are highlighted in yellow. In these cases, subsequent performance was typically strong. For example, in the 24 months leading up to the 1974 rate cut, the Index was already down -44% and in a significant bear market. In response, the Fed cut rates and the DJIA rebounded, gaining +42% over the next twelve months. • Periods highlighted in blue are when the market increased +10% or more in the 24 months before the cut. In these instances, subsequent performance tended to be subdued – and in some cases, negative. For example, in 2007 the market was up almost +24% in the 24 months preceding the first rate cut, but the DJIA actually lost -11% in the following twelve months. Furthermore, the total bear market losses that followed in 2008 and 2009 were in excess of -50%! There are clearly exceptions to this relationship, though some of those easing cycles ultimately led to bubbles that inevitably popped, like the cuts prior to the ’29 Crash and the late ‘90s Tech Bubble. The small table summarizes this analysis well. When the DJIA lost -10% or more in the 24 months leading up to a first rate cut, gains in the following 12 months were typically strong with an average of almost +30%. On the contrary, when the DJIA rose +10% or more in the 24 months leading up to a first rate cut, the following 12 months often saw minimal gains or even losses with an average of only +2.6%.
