The performance of the S&P 500 following the Federal Reserve's rate cuts largely hinges on whether the economy is in a recession or not.
According to a detailed analysis by Vickie Chang, an analyst at Goldman Sachs, historical data reveals a sharp contrast in how equities react to rate cuts during recessions compared to other economic phases.
Chang noted that in recessionary periods, stock markets typically experienced meaningful declines after the Fed's initial rate cut. In contrast, during "growth scares" or "normalization" periods, equities have rallied strongly.
"History tells us that why the Fed is cutting matters-asset performance around the start of the easing cycle has differed depending on what motivated Fed cuts," Chang explained.
Goldman Sachs analyzed 10 Fed rate-cutting cycles starting from 1984, four of which were associated with recessions (1990, 2001, 2007, and 2020). The remaining six non-recessionary episodes were categorized as either "growth scare" periods (1987, 1998, 2019) or "normalization" periods (1984, 1989, 1995).
First cut dateType of episode
- September 1984Normalization
- October 1987Growth Scare
- June 1989Normalization
- July 1990Recession
- July 1995Normalization
- September 1998Growth Scare
- January 2001Recession
- September 2007Recession
- July 2019Growth Scare
- March 2020Recession
How Equities, Bonds, And Volatility Behave After The First Fed Cut
The S&P 500's performance diverges sharply between recessionary and non-recessionary episodes.
The S&P 500, as tracked by the SPDR S&P 500 ETF Trust
In "normalization" periods, where the Fed cuts rates to bring them back to lower, more sustainable levels after previously hiking them during expansionary times, the S&P 500 also showed positive performance, rising by 5% after three months and 7% after six months.
During recessions, the stock market tells a very different story.
The S&P 500 experienced sharp declines of 11% three months after the first rate cut and remained in the red, down 10% after six months.
This underscores the fact that rate cuts, while intended to stimulate the economy, often come too late to stop the downward momentum in recessions, and stocks struggle as corporate earnings decline and economic activity contracts.
The VIX, a measure of stock market volatility, also reacts differently depending on the economic backdrop. In growth scare scenarios, volatility tends to decrease significantly after rate cuts. In normalization periods, the VIX initially spikes by 17% three months after the first rate cut, but this increase is short-lived. Volatility stabilizes, dropping to -1% six months after the first cut.
In stark contrast, during recessions, the VIX tends to rise following rate cuts. Volatility surged by 21% three months after the first cut and remained elevated, still up 9% after six months.
Regarding the performance of bonds in recessionary periods, the yield on the 2-year Treasury fell on average by 65 basis points (bps) three months after the first cut and continued to decline, dropping by 82 bps six months in.
Similarly, the 10-year Treasury yield fell by 23 bps three months after the first cut and dropped by 30 bps six months later.
The 'Why' Behind Fed Cuts Drives Market Behavior
The data clearly shows that asset performance diverges sharply based on the economic context in which the Federal Reserve initiates rate cuts.
- In recessionary periods, rate cuts often coincide with significant declines in both equities and bond yields, accompanied by a spike in volatility.
- In growth scare or normalization periods, equities tend to rally, bond yields fall more moderately, and volatility subsides as market participants regain confidence.
Investors should closely watch not only the Fed's actions but also the reasons behind the rate cuts, as the broader economic context will determine how markets react.
