Last week, the Federal Reserve released hawkish signals, and the market expects the Federal Reserve to pause interest rate cuts in January. What does this mean for major Assets?

On December 19, Citigroup's Global Macro Strategy team, including Analyst Dirk Willer, analyzed in a report the performance of macro assets during previous periods of pause in easing cycles, distinguishing between a pause and the end of an easing cycle.

In summary, Citigroup found that US Stocks typically perform well, but the sustainability of the rise depends on whether economic weakness will lead to a restart of policy easing; US Treasury yields generally rise at the pause or end of the cycle; for the USD, if the rate cut is merely paused, the USD exhibits sideways performance, while if it is the final rate cut, the USD will rise; after a pause, whether the easing cycle continues or not, Gold prices usually rise.

Bullish for US Stocks in the short term, but the long-term outlook depends on whether easing will resume.

According to Citigroup, when the Federal Reserve pauses or ends interest rate cuts, risk assets typically perform better, but the sustainability of the rebound depends on whether economic weakness leads to a resumption of policy easing.

For$S&P 500 Index (.SPX.US)$In the case of a pause, stocks may rise but will only be sold about a month later, due to further easing being a result of deteriorating economic data, which could put pressure on stocks. In contrast, if the pause is confirmed as the final interest rate cut, the rebound in US stocks will be more lasting, although the dispersion of returns will be greater.

Historically, only during the pause in interest rate cuts in 1989 did the S&P 500 briefly rebound and then correct by 10%. In 1998 and 2003, after the end of the easing cycle, the S&P's rebound lasted for three months. Citigroup stated that overall, the data is constructive for Stocks at least in the short term.

Bearish for US Bonds.

According to Citigroup, for fixed income investments, pausing interest rate cuts typically leads to an increase in yields.

As shown in the figure below, the initial phase of pausing interest rate cuts results in a higher rise in yields, whereas the impact of rate cuts at the end of the easing phase initially has a smaller effect on yields but then shows a more significant increase, for example, yields may rise by 50 basis points within a few months.

Overall, this research is not optimistic about the outlook of US Treasury yields, further confirming Citigroup's current strategy of underweighting US rates in Global Asset allocation.

Ending interest rate cuts is Bullish for the USD.

Citigroup's research shows that compared to the pause in interest rate cuts, ending interest rate cuts is overall more Bullish for the USD.

If at the end of an easing cycle, the USD will remain strong, but if it is just in a pause period, the USD tends to fluctuate. As shown in the figure below, pauses often lead to$USD (USDindex.FX)$range trading, and if confirmed as the end of the easing cycle, the USD will experience a larger increase.

Bullish on Gold.

Research shows that regardless of whether the easing cycle continues, Gold prices usually rise.

The figure below shows that Gold prices generally trend upwards, even at the end of an easing cycle. This study broadly supports Citi's bullish stance on Gold based on central bank demand.

During the pause in rate cuts, US stocks will still outperform European stocks.

During the pause period, the relative outperformance of US Stocks compared to European Stocks generally continues, but it is very unstable. If it is at the end of the easing cycle, US Stocks show a significant pullback relative to the Europe Stoxx 50 Index, but overall also presents sideways fluctuations.

Small Cap Stocks outperform Defensive Stocks.

Citi pointed out that if the pause is confirmed to be the end of the easing cycle, small-cap stocks will perform better than defensive stocks.

As shown in the figure below, if the easing cycle ends, small-cap stocks will significantly outperform utility stocks. However, if it is merely a pause, small-cap stocks are likely to trade within a range compared to utility stocks. Citi concluded that this overall remains favorable for small-cap stocks rather than utility stocks.

Emerging Markets arbitrage performs well.

Citi stated that Emerging Markets arbitrage should perform well, especially if this is just a pause in the cycle.

If the Federal Reserve merely pauses interest rate cuts, Emerging Markets arbitrage will continue to trade very well. If the situation is the end of the easing cycle, Emerging Markets arbitrage will eventually also trade well but will initially experience a sharp decline. Overall, the Federal Reserve's pause or the end of the cycle will not undermine bullish and bearish arbitrage trading.

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