Stock market braces for significant boost following the latest four-year interest rate reduction?
The Federal Reserve, in a move to combat inflation following the pandemic years, reduced the key interest rate in September 2023, marking a four-year gap since the last cut. This reduction was the first step in a series of planned further interest rate cuts for 2024 and beyond into 2025.
Historically, Federal Reserve interest rate cuts have often led to positive stock market returns in the following year. Since 1929, out of 14 Fed rate-cut cycles, 12 saw the S&P 500 rise in the 12 months after the first cut, with the market often at or near highs when cuts occurred. However, it's important to note that this relationship is not guaranteed and depends strongly on the economic context at the time.
Since 1994, a 10% decline in the stock market has predicted about a 32 basis point Fed funds rate cut at the next FOMC meeting and a 127 basis point cut over the following year. This suggests that the Fed reacts to market downturns to support growth expectations.
The Fed’s internal growth expectations updates are strongly influenced by stock returns, with declining markets leading to downgrades in growth forecasts, which then motivate rate cuts. Market enthusiasm tends to view rate cuts as signals of looser liquidity and potential asset price increases, but historically, this is nuanced and depends on the broader macroeconomic environment and investor sentiment during each rate-cut cycle.
Current market sentiment as of 2025 shows high expectations for a 25 basis point cut at the September FOMC meeting and additional cuts later in the year. This has coincided with rising equity prices despite some economists warning of a disconnect between the stock market and underlying economic conditions.
However, investors should be cautious. Rate cuts can be interpreted as responses to economic weakness, which may temper enthusiasm. The market may be pricing in multiple cuts already, reducing the surprise or rally potential. The macroeconomic and global environment can significantly influence outcomes.
Total cuts of 125 basis points are expected in 2025, followed by a 25 basis point reduction in 2026. While the stock market generally performs well after Fed rate cuts, especially when cuts follow market declines, the specific conditions in 2024–2025 require careful analysis.
It's also worth noting that the American S&P 500 index, an important indicator for Germany, has shown that since around the year 2000, interest rate cuts are often accompanied by a decline in stock prices. Over a long period, the S&P 500 has statistically provided investors with a decent return through patience.
Despite the unemployment rate in the US rising from 3.7 percent to 4.1 percent since the beginning of the year, the current economic situation is not as dire as it was in the past. Low interest rates are beneficial for stock markets as they make it easier for companies to take out loans or reduce interest-bearing debt. However, risk-free investments like savings accounts become less attractive compared to growth stocks due to lower profits with bank products.
Falling interest rates often cause stock markets to drop, at least temporarily. But further interest rate cuts could lead to rising stock prices, although this is not guaranteed. The bond market and other asset classes may react differently, with some forecasts suggesting that anticipated rate cuts may already be priced in and that long-term yields could actually rise if cuts are seen as inflationary, potentially complicating the liquidity impact on stocks and bonds.
In conclusion, while the Federal Reserve's planned interest rate cuts in 2024 and beyond into 2025 could potentially lead to stock market gains, investors should approach the situation with caution, considering the economic context, market sentiment, and the broader macroeconomic environment.
Investors might find opportunities for investing in the stock-market with the planned interest rate cuts by the Federal Reserve, as history shows that such cuts often lead to positive stock market returns in the following year. However, it is essential to examine the specific conditions in 2024–2025 and consider the economic context, market sentiment, and the broader macroeconomic environment before making any investment decisions in the stock-market or finance sector.
