How Fed Rate Cuts Have Moved Stock Before

Whether the Federal Reserve can prevent a recession in time could be crucial.

A Fed interest-rate cut on Wednesday seems all but certain, but how the stock market reacts to this loosening of monetary policy remains highly uncertain.

History offers some insight: why the Fed is cutting rates matters more for markets than the mere fact that borrowing costs are falling.

Vickie Chang, a macro strategist at Goldman Sachs, noted that since the mid-1980s, the Fed has cut rates 10 times. Four of those cuts were during recessions, while six were not. When the Fed managed to avoid a recession, stocks typically rallied. When it failed, stocks usually declined.

Investors likely won’t get all the answers on Wednesday. How the market responds will depend on economic data in the months ahead.

“The key question is whether this rate-cutting cycle is due to a ‘growth scare’ or a more serious ‘recessionary’ phase,” Chang said.

In recessionary rate cuts, the S&P 500 typically drops 10% within the first six months.

What will Wednesday’s cut reveal about the economy?

The size of the cut could heavily influence investor sentiment and potentially shape market behavior for the rest of the year.

Investors are particularly eager for clarity, given the mixed signals from recent U.S. economic data. While hiring has slowed, more people have entered the workforce, and layoffs remain low. Inflation has eased, but certain costs, like rent and housing, remain stubbornly high.

Optimism earlier in 2024 fueled stock gains, but investor confidence has since been shaken, leading to selloffs in August and September, as concerns about rising unemployment grew.

Has the Fed fallen behind?

Some experts believe the Fed should have cut rates back in July, and a larger-than-expected 50 basis point cut this Wednesday could spark a negative reaction in the stock market. Wall Street sees such a move as a sign that the Fed may have fallen behind or is reacting to worse-than-expected economic data.

Shannon Saccocia, CIO at Neuberger Berman Private Wealth, said, “A 50 basis point cut would suggest the Fed missed the window in July or has more worrying data than we’ve seen.”

This uncertainty could trigger a market selloff regardless of the Fed’s decision, according to Deutsche Bank strategists. They noted that the Fed could deliver the biggest market surprise in 15 years, regardless of the cut’s size.

Beyond the cut itself, the Fed’s updated economic projections will be carefully scrutinized.

John Velis, a macro strategist at BNY Mellon, anticipates that the Fed will revise its unemployment forecast higher while lowering GDP growth projections. While this may not signal a recession, it could influence how aggressively investors expect the Fed to cut rates moving forward.

On the edge of a historic achievement

Though there are no clear signs of a recession yet, investors remain cautious.

If Fed Chair Jerome Powell can guide the economy through inflation without causing a downturn, it would be a monumental achievement. KPMG U.S. chief economist Diane Swonk pointed out that achieving a soft landing would be unprecedented.

While inflation complicates the current situation, the Fed has successfully navigated difficult economic conditions before. In 1995, a series of rate cuts helped avoid a recession, according to Jurrien Timmer, global macro director at Fidelity.

“It’s rare, but it’s possible,” Timmer told MarketWatch.

Last week, the S&P 500 and Nasdaq Composite posted their biggest weekly gains since November 2023, with the Dow Jones Industrial Average also seeing its best week in a month.

The Fed’s two-day September policy meeting starts Tuesday, with the interest-rate decision to be announced Wednesday at 2 p.m. Eastern Time.