Fact Check: Are Interest Rate Cuts Good For Stocks?
Investing.com | Jun 13, 2019 04:04
With the world's two most important and closely watched central banks—the European Central Bank (ECB) and the U.S.'s Federal Reserve—now talking fairly openly about cutting interest rates, regional as well as global markets have been rallying in anticipation. Indeed, even the most benign comment by Fed officials tends to make headlines, and often drives markets higher or lower immediately afterward.
Common knowledge has long said that rate cuts are good for equities. But is that actually true? Does a Fed rate cut have a positive impact on the markets after a period of rising rates? A look at market performance over the past 30 years, around the time of a rate cut, tells us three things:
1. From 1989 through 2007, every single rate cut was preceded by strong performance in the stock market, once the upcoming event was telegraphed by the Fed. On average, the S&P 500 gained 3.5%, before the actual cut. That's nearly five times higher than the average monthly performance of the benchmark, which is 0.74%.
Of course, this reflects the fact that a rate cut is not a surprise event. The Fed doesn't want to create volatility by surprising markets, so it telegraphs lower rates long before the cut actually occurs. Indeed, a month before the Fed meeting is the perfect time to advertise the move, as is evident by the market’s performance—investors clearly get the hints and price in the cut long before it happens.
We're experiencing just such a setup right now. Last week Powell said the Fed will "act as appropriate," signaling rates are likely to head lower. Currently, consensus says there's a 69% chance the Fed will cut rates at its July meeting, up from 20% last month.
Though the next meeting is scheduled for June 19, that's considered too early for the interest rate decision to take place, especially since the Fed hasn't had the time to properly communicate the event as is its preference. Still, the market narrative says we may be approaching the first Fed rate cut in over a decade, since Dec.16, 2008.
2. A rate cut does help falling markets stabilize in the short term. In 1998, 2001 and 2007, the S&P 500 performance during the previous three months leading into the rate cut was negative. Hinting at a cut then delivering on one meant the months around the cut were positive for the index, and the event also helped calm then turbulent markets.
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3. Cuts are not a magic remedy for an ailing economy, however. As is evident by the market's performance three months after and even a year later, lower rates didn't necessarily buoy equities over the longer term. In 2001 and 2007, lower rates weren't able to prevent subsequent market crashes. It’s impossible to tell if cutting rates mitigated the slides, but it clearly didn’t prevent them. Over the longer haul, rate cuts don't guarantee a strong stock market performance.
The likelihood of a Fed rate cut in July is getting higher. The market has already started pricing that in. Additional hints will create a strong performance window into July.
Still, caution is always advised. The exceptionally low interest rates seen over the past decade or so have taken us into uncharted territory with little historical, macro perspective for guidance.
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