The Bank of England joined the group of central banks that have cut interest rates this year when it trimmed Bank Rate from 5.25% to 5.0% on 1 August. The Federal Reserve, meanwhile, left the fed funds rate unchanged when it concluded its two-day meeting a day earlier. Jerome Powell did, however, indicate that a reduction may be on the cards soon. But when the Fed does start cutting rates, how gradually and how far will it go – and what are the implications for investors?
Previous Fed rate-cutting episodes may not offer that many clues. The length of rate-cutting cycles and the amount that rates are cut in those cycles has varied considerably over the past 40 years. In other words, easing cycles can be very different in nature. One common thread is that the Fed typically cuts rates ahead of, or during, recessions. But while we expect the US economy to slow in the coming quarters, we do not foresee an outright US recession on the cards anytime soon – meaning that there may be less impetus to cut in the current cycle relative to previous cutting cycles.
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Asset price performance during previous Fed easing cycles has been mixed – at least in the case of US equities, EM equities, the US dollar and oil. It seems that it is not the actual rate cuts that are the main driver of returns, but rather, it is the reason behind those cuts that drives asset prices. These reasons, in turn, influence the duration and speed of loosening.
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All of that said, one trade does seem to be a winner: buying US Treasuries. In each of the FOMC’s seven easing cycles since the early 1980s, the yield on both 2-year and 10-year US Treasuries has fallen (measured using the yields at the end of the month before the first cut and the end of the month after the last cut). Of course, bond trading is more complicated than simply buying a bond when the reference rate is high and selling it when the reference rate is lower. And in real time, investors do not know for sure when a loosening cycle will begin or end. Nevertheless, assuming that the Fed does cut rates soon and this relationship holds for an eighth time, owning US Treasuries appears to be a good shout.
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Another aspect for investors to consider is the synchronicity of policy moves across the major economies. The Federal Reserve is often at the forefront of global monetary cycles – tightening before others tighten and easing before others ease, as reflected in the chart below. However, the Bank of Canada, Bank of England and European Central Bank, whose policy rates are most closely correlated with the fed funds rate (out of the G10 currencies and BRICS), have all loosened already this year. Assuming we are on the cusp of a global easing cycle, the Fed appears to be the laggard. This has caught investors by surprise somewhat and helps to explain why the US dollar has appreciated against most major currencies in 2024.
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The views expressed in this article are the views of the author, not necessarily those of LSEG.
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