Fed rate cut is definitely good for the stock market? Analyst: Not necessarily! It depends on this factor
The impact of the Fed's interest rate cuts on the stock market depends on whether a recession is imminent. Historical data shows that the stock market usually rises in the days following the first rate cut, but declines in the weeks following when the economy begins to contract. While a recession may hit the stock market, investors can still benefit from holding bonds as bonds tend to outperform stocks during economic downturns. When a recession is avoided, stocks often outperform bonds. Additionally, earlier this week, US Treasury yields fell to their lowest level in over a year
The Fed's rate cut will bring some relief to companies struggling with soaring borrowing costs. However, historically, rate cuts are not always beneficial to the stock market.
According to information from the Wise Finance APP, Andrea Cicione, research director at GlobalData and TS Lombard, pointed out that this depends on whether the economy is on the verge of a recession. Cicione wrote in a report to clients on Friday, "Lower interest rates are usually a response to an economic downturn."
To illustrate this point further, his team tracked the performance of the S&P 500 index during Fed rate-cut cycles from 1984 to 2019. The data shows that in the days following the first rate cut, the stock market usually rises. However, when the economy begins to contract, the stock market also starts to decline in the weeks following the first rate cut.
After a turbulent week, U.S. stocks rose on Friday, with the S&P 500 index up 0.47%, the Dow Jones Industrial Average up 0.13%, and the Nasdaq Composite Index up 0.51%. During the week, the "fear index" (CBOE Volatility Index) surged, and global stock markets plummeted on Monday as investors suddenly unwound yen carry trades. In addition, the weak July jobs report has raised more concerns about the resilience of the U.S. economy.
While a recession could hit the stock market, Cicione pointed out that investors may still benefit from holding bonds when a recession occurs, as bonds tend to outperform stocks on average during economic downturns.
On Friday, the yield on the 10-year U.S. Treasury note was 3.94%, having earlier fallen to 3.78% earlier in the week, the lowest level in over a year. He wrote, "However, when a recession is avoided, stocks tend to outperform bonds in the long run."