Advisor, What Does a Rate Cut Mean for Stocks and Bonds?

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In his remarks at Jackson Hole last month, Federal Reserve (Fed) Chair Jerome Powell stated, “The time has come for policy to adjust.” Citing diminishing upside inflation risk and rising downside risk to employment as catalysts for the policy pivot, his remarks were based on the data. Now, several weeks later, and with the payrolls report falling shorter than expectations, this additional data will help write the narrative for the Fed’s meeting on September 18.   

 As highlighted below, the fed funds futures market has fully priced in a 0.25% cut at the September 18 Fed meeting, with odds for a 0.50% reduction running at around 30%. Implied probabilities point to four or five 0.25% cuts by year-end.  

_{Source: LPL Research, Bloomberg 08/29/24
Disclosures: Past performance is no guarantee of future results.}

Historical Implications in the Stock Market

With monetary policy widely expected to pivot to rate cuts, the next big question is what happens after the Fed begins to cut interest rates. Based on the last nine major rate-hiking cycles since the 1970s, the S&P 500 has generated mixed, modest returns over the three months following the first cut, with 12-month average and median returns of 5.5% and 10.8%, respectively. Furthermore, 12-month maximum drawdowns following the first cut have been around 19%–20%, larger declines than the average maximum drawdown for all years since 1974 of 14.4%. Of course, how the economy holds up and if we enter or avoid a recession will ultimately dictate how stocks perform over the longer term. At LPL Research, we believe a soft landing is still viable but not guaranteed, potentially setting stocks up for a few volatile months, likely exacerbated by the November election.

_{Source: LPL Research, Bloomberg 08/29/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.} 

“12-month maximum drawdowns following the first cut have been around 19%–20%, larger declines than the average maximum drawdown for all years since 1974 of 14.4%.”

What About Bonds?

Using the same rate-cutting periods from above, we also analyzed how 10-year Treasury yields historically progress after the Fed starts cutting rates. As highlighted below, yields tend to decline over the following 12 months, falling by an average of around 25 basis points (bps). The lows for the 10-year occurred at the six-month mark, where the average decline reached 46 bps, with eight of nine periods posting lower yields, marking the lowest positivity rate across the 12-month time frame.  

_{Source: LPL Research, Bloomberg 08/29/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly. Progression data based on cuts cited in previous table, ranging from 1974–2019.}

Limited Time Webinar Opportunity — Adapting Portfolios in a Changing Rate Environment

This evolving landscape sets the backdrop for our upcoming webinar, Delivering Holistic Advice in a Changing Rate Environment. Created for financial advisors by LPL Research in partnership with LPL Banking and Lending, attend and you’ll hear about strategies to help navigate market implications, uncover opportunities, and keep your clients’ portfolios on track.