What Happens When the Fed Cuts Interest Rates?

Going back to the 1950s, when the Federal Reserve began cutting interest rates, the stock market finished the next 12 months negative five times but positive 16 times. Of those 16 times, a recession accompanied nine, and the other 7 saw an expansion.

On average, the market gains 11% following cuts with no recession and gains 8% even if there is a recession. So, what’s the takeaway here? The market is more likely to trend higher following a cutting cycle, whether there’s a recession or not. It doesn’t care unless there’s a shock. For instance, 2001 and 2008 were deleveraging events (SHOCK), and 2020 was a black swan(SHOCK).

The Current Economic Situation

Today, the U.S. economy has entered a late-cycle slowdown with rising unemployment, falling job growth, and sluggish economic activity. The world’s second-largest economy also continues to suffer, which could negatively affect the global economy. The oil market also reflects less global demand, signaling a possible global recession.

Traditionally, GDP growth should be turning negative, but that’s just not the case yet. Consumers may have given up on purchasing goods, but they haven’t given up on experiences. Banks’ willingness to extend credit is actually rising. Household wealth is at an all-time high, partly because homeowners saw the largest surge in home prices in a decade, increasing their equity values. Plus, the stock market is also at all-time highs.

Recent economic data shows better-than-expected retail sales, industrial production, building permits, and housing starts. Naturally, lower rates should accelerate activity. As long as inflation falls, the Fed and the Treasury can keep on pumping.

Market Reactions to Rate Cuts

Following the Wednesday rate cut, utilities, technology, and Bitcoin have all outperformed the S&P 500. Utilities are the typical recession hedge – a stable industry with consistent earnings. Most people are going to pay their utility bill before they take a trip to the Bahamas. Well, hopefully.

Utilities also have a mega growth driver behind them. With the rise of AI, data centers are popping up like mushrooms, which means more electricity revenue. Constellation Energy just committed to restarting a nuclear plant to support energy demand for Microsoft’s data center needs. That stock's up 20% on the day.

The Nasdaq is breaking out of a technical pattern, led by Meta making all-time highs. Tech is probably playing catch up, as it seems underperformed the S&P since the yen carry trade crisis.

Bitcoin and Liquidity

Bitcoin represents crypto and is a pure play on liquidity. When global money supply growth accelerates, Bitcoin accelerates. Rate cuts effectively increase the demand for borrowing, leading to more loans, more margin, and an overall rise in global liquidity. Bitcoin is a cyclical asset, which means it also loves tax cuts. In 2017, the Fed raised interest rates, but the fiscal impulse from Trump's tax cuts helped Bitcoin rip higher.

So if you’re betting on tax cuts, you’re betting on Bitcoin and crypto. Either way, the election cycle brings the biggest bundle of economic promises, which equates to more economic stimulus. With both candidates being big spenders, cyclical assets are likely to boom.

What to Expect

Historically, markets are more likely to perform when the Fed starts a cutting cycle. During the four years of an election cycle, markets perform best during the pre-election year (the promises) and the post-election year (the delivery). So, hold on tight. The promises are still building, and the delivery is coming.