How Markets React When the Fed Cuts Rates — Context Is Everything

Jeffrey Roach (00:00):

Hi, I am Jeffrey Roach, Chief Economist for LPL Financial, and in this latest edition of the Street View podcast, we'll address the question, how do stocks historically behave when the Fed starts cutting rates?

Jeffrey Roach (00:13):

Okay, so let's set the stage. In the past several months, investors have taken an absolute rollercoaster ride with rate cut expectations. As we recently wrote in our Weekly Market Commentary, markets were expecting the Fed to cut at least four times earlier this year. Now, fast forward a few weeks, expectations fell to just one and a half cuts, and then things changed after the weak jobs report. So let's briefly discuss rate cuts and then talk about what happens in the markets. So the Federal Reserve's decision to cut interest rates is often viewed as a pivotal moment for financial markets. So while rate cuts during recessions tend to coincide with market stress and declining equity prices, the story is marketably different when the Fed eases policy during non-recession periods, typically categorized as growth scares or normalization phases. Historical data reveal, the S&P 500 has generally performed well following rate cuts outside of recessions. In episodes during the 80s and 90s, not accompanied by a formal recession,

Jeffrey Roach (01:16):

The index posted positive returns in the months following the first rate cut. So first, during growth scare periods, where the Fed cuts rates in response to slowing, but still expanding economic activity, the S&P 500 has shown particularly strong performance. These rallies reflect investor optimism that monetary easing will successfully stabilize growth without tipping the economy into contraction. Now, second, in normalization scenarios where the Fed reduces rates after a period of tightening to maintain balance, well, the S&P also tends to rise, albeit more modestly. These periods often reflect recalibration of policy rather than a response to crisis, which markets interpret as a constructive backdrop for equities. So the key takeaway is this, the context of the rate cut matters. When cuts are proactive rather than reactive, aimed at sustaining expansion rather than rescuing a faltering economy, markets tend to respond favorably. For investors, understanding the motivation behind Fed policy shifts is crucial to interpreting their likely impact on equity performance. Well, that's all for now, but please follow us on social media and take care.