Although people cannot be sure whether the Fed will cut interest rates by 25 basis points or 50 basis points tonight, the opening of the Fed's easing cycle is already a done deal. And it can be foreseen that this easing cycle, the steps taken by the Fed are likely to be significant:

LSEG's data shows that market traders currently expect the Fed to cut interest rates by about 250 basis points by the end of 2025.

So, as the Federal Reserve once again stands at the "crossroads" of a major monetary policy shift, historically, what impact will the Fed's interest rate cut have on the stock market, bond market, and foreign exchange market?

Multiple historical statistics show that after the Fed officially starts a rate cut cycle, the performance of the dollar, U.S. bonds, and the dollar may mainly depend on one factor: the health of the U.S. economy.

Evercore ISI's market statistics dating back to 1970 show that if the U.S. economy enters a recession,$S&P 500 Index (.SPX.US)$Within six months after the first interest rate cut in the easing cycle, the S&P 500 index tends to average a 14% increase when the Fed cuts rates during non-recession periods, compared to an average 4% decline when the U.S. economy experiences a recession.

Keith Lerner, Co-Chief Investment Officer of Truist Advisory Services, said, "If the economy enters into a recession, the support of interest rate cuts will not be sufficient to offset the decline in corporate profits and the high level of uncertainty and lack of market confidence."

In addition, in the bond market, US Treasury bonds tend to perform well during economic recessions, as investors are more eager to seek the security provided by the safe-haven asset of US Treasury bonds. The appreciation of the US dollar during an economic recession is often smaller, although its performance may depend on the comparison of the US economy with other countries...

US stocks

Typically, the National Bureau of Economic Research (NBER) is responsible for determining whether the US economy is in a recession, but its findings are lagging indicators. Currently, although some warning indicators are starting to flash "red lights", economists have hardly seen any evidence that the US is experiencing a recession.

If this situation continues, it will be a positive sign for the current rebound in the US stock market.

James Reilly, Senior Market Analyst at Capital Economics, stated in a report, "Based on the previous easing cycle, our expectation of a significant interest rate cut by the Federal Reserve and no recession in the US economy is consistent with the statistical performance of strong returns in the US stock market."

Of course, recent concerns about the economic outlook have actually led to significant volatility in asset prices: signs of weakness in the US labor market have caused substantial fluctuations in the S&P 500 Index, and concerns about global economic growth have been reflected in the sharp decline in commodity prices - the trading price of Brent crude oil is currently nearing its lowest level since late 2021.

The speculation about whether the US economy will only decline to its long-term trend or show more significant signs of slowdown is also a major reason for the recent back-and-forth expectations in the interest rate futures market of a 25 or 50 basis point rate cut.

The chart below shows the performance of the s&p 500 index after the first rate cut by the Federal Reserve in each easing cycle since 1987. The statistics classify Federal Reserve rate cuts into three categories: rate cuts needed for "normalization" of interest rates, rate cuts due to market "panic" (such as Black Monday), and rate cuts in the context of economic recession:

It is easy to see that the economic conditions are very important for investors to assess the long-term performance of US stocks. According to the research by Ryan Detrick, Chief Market Strategist at the Carson Group, after the first rate cut during an economic recession, the s&p 500 index dropped an average of nearly 12% one year later. In comparison, during non-recession periods, when rate cuts were needed for interest rate "normalization", US stocks on average could rise by 13% one year after the rate cut.

Michael Arone, Chief Investment Strategist at DowDuPont Global Advisors, said the key to the whole thing is whether the economy can avoid a recession.

Of course, if we do not carefully distinguish whether there is an economic recession or not, overall, the s&p 500 index can on average rise by 6.6% in the year following the first rate cut. However, this may not be considered a particularly outstanding "report card" - this performance is about one percentage point lower than the average annual return since 1970.

In terms of specific sectors, among the 11 major sectors of the s&p 500 index, $Consumer Staples (LIST20756.US)$ and $Consumer Discretionary (LIST20755.US)$ The industry performs the best on average after a year of interest rate cuts, with an increase of around 14%, followed closely by the medical care industry (12%) and the technology industry (nearly 8%).

Small cap stocks, which are highly sensitive to signs of economic improvement, often perform well.$Russell 2000 Index (.RUT.US)$They have averaged a 7.4% increase in the year following the first interest rate cut.

US Treasury Bonds

US Treasury bonds have always been a popular investment option when the Federal Reserve begins an interest rate cut cycle. However, currently, US Treasuries have already experienced a significant rebound before the rate cut, which has led some investors to believe that unless there is a recession, the bullish market for US Treasuries is unlikely to expand further.

As is well known, the yield on government bonds is inversely related to the price of bonds. When the Federal Reserve eases monetary policy, bond yields often decrease with interest rates. The safe-haven reputation of US Treasuries also makes them a popular investment during periods of economic uncertainty.

Therefore, the impact of economic prospects on the trend of U.S. Treasuries is also very pronounced. Citigroup strategists have found that the median return on the Bloomberg U.S. Treasury Bond Index in the 12 months following the first interest rate cut was 6.9%, but in the case of a "soft landing" of the economy, it was only 2.3%.

Citi's Global Head of Macro and Asset Allocation Strategy, Dirk Willer, said that if there is no so-called economic hard landing - which would force the Fed to cut rates more aggressively than expected, then the further rise in US Treasuries may not be so certain. Willer pointed out, "If the economy experiences a hard landing, a lot of funds will flow into the bond market. But if it's a soft landing, the situation is really unclear."

In addition to economic performance, early buying may also be crucial. Data from CreditSights shows that in the past 10 rate-cutting cycles, the yield on the 10-year US Treasury bonds has on average dropped by 9 basis points in the month following the first rate cut, and it has increased by 59 basis points one year after the first rate cut - because investors have started pricing in the economic recovery at this point.

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How will the Fed's rate cuts affect the US dollar? Historically, the US economy and the actions of other central banks are the two important factors that determine how the US dollar reacts during a Fed easing cycle.

First, let's look at the economic factors. Economic downturns often require a bigger rate cut by the Fed, and the rate decrease will weaken the attractiveness of the US dollar to yield-seeking investors.

Goldman Sachs' analysis of the past 10 Fed rate-cutting cycles shows that under the condition of no recession, the median exchange rate of the US dollar against a basket of trade-weighted currencies increased by 7.7% one year after the first rate cut. In contrast, when the US economy was in a recession, the dollar's increase during the same period was only 1.8%.

Meanwhile, according to another analysis by Goldman Sachs, when the US simultaneously cuts rates with multiple non-US central banks, the US dollar's performance tends to be better than other currencies. When the Fed cuts rates simultaneously with relatively fewer non-US banks, the US dollar tends to show weaker performance.

Currently, major central banks such as the European Central Bank, the Bank of England, and the Swiss National Bank are also cutting rates. The ICE, which measures the strength of the US dollar against a basket of currencies$USD (USDindex.FX)$The U.S. dollar has been weakening since late June, but it has still risen by about 9% over the past three years.

Yung-Yu Ma, Chief Investment Officer of Bank of Montreal Wealth Management, stated, "The U.S. economy is still doing better than most countries. Even with the significant strengthening of the dollar in recent years, we do not anticipate a significant weakening of the USD."

However, analysts at BNP Paribas do not agree. The bank stated that if the U.S. economic growth weakens, this situation could change. "We believe that in the potential recession risks, the Fed may cut interest rates more than other central banks, further weakening the yield advantage of the USD, making the USD more vulnerable."

Editor/Rocky