Last week, global equities staged a strong recovery as the Fed held rates steady and struck a more dovish tone, hinting that the current rate-hiking cycle may be over. Is this a cause for bullishness? Will the inevitable rate-cutting cycle be positive for stocks when it comes?
To test this question, we compare the 12-month change in the Fed Funds rate to the return of the S&P 500 over the same period.
We sort each of these 12-month periods since 1985 into eight equal buckets based on the change in the benchmark interest rate over that period. The chart below shows the average market return for each bucket.
Source: Bloomberg
This shows quite clearly that equities like stable rates more than preferring hiking or cutting cycles. The intuition behind this is most likely that while rate cuts generally tend to stimulate future economic growth, sharp rate cuts normally coincide with an economic or financial crisis. And while rate hikes eventually lead to slowing growth and sometimes debt blow-ups, mild rate hikes often coincide with a strong economy.
These competing mechanisms lead to the clearly non-linear relationship we see in the chart above. With the Fed possibly done with rate hikes but committed to maintaining tight policy for an extended period, we could see a stable policy rate well into next year.
While this ‘higher for longer’ scenario may be seen as a negative to some, historic data suggests it could be supportive of equity market returns into 2024.
Our Market Snippets aim to provide concise insight into our investment research process. Each week, we highlight one chart that showcases our research, motivates our current positioning, or simply presents something interesting we’ve discovered in global financial markets.
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