Source: CFA Institute Stocks, Bonds, Bills and Inflation (SBBI®) database and M&G Wealth Investments. Total returns in USD. Fed Funds Data taken from Federal Reserve (FRED) website. Taken from past 7 times the Federal Reserve has cut interest rates. Recessionary periods indicate a recession occurred within 12-months after the Federal Reserve cut interest rates. 30th September 2024.
We looked at the 12-month returns for US stocks and US bonds from the date of the first rate cut during the last seven US interest rate cutting cycles by the Federal Reserve. We found that bonds tend to do well in an interest rate cutting scenario, whereas stocks produce mixed results.
This means for multi-asset portfolios, there is not a standard playbook for asset returns in the 12 months after the Federal Reserve cuts interest rates. But there is a clear difference in performance when we separate recession and non-recession periods. If the economy is heading for recession and the Federal Reserve cuts interest rates, it tends to be a bad time for multi-asset returns, especially for stocks as companies’ profits fall. If the Federal Reserve cuts rates without a recession, companies and households benefit from lower borrowing costs and growth stays positive. This is usually good for multi-asset returns with stocks outperforming bonds.
So what environment are we in today?
The key question is whether the US will fall into recession over the next year. When we look at the data, the US economy recently added 254,000 new jobs in September and the latest estimate of annualised US GDP Growth is 3.2% for Q3 20241. Typically, during recessions both of these numbers are negative suggesting we are a way off recessionary levels today. We must admit there is some concern when investors look at US unemployment, which has risen from a rate of 3.4% to 4.1%. But we think much of this rise is due to increased immigration meaning more workers are looking for jobs, rather than people losing their jobs. We think a US recession in the next twelve months is unlikely.
Given that the US economy is still healthy and expanding, we believe lower US interest rates are supportive for multi-asset portfolios. The past four times rates were cut and the US did not enter recession, US equity returns averaged 22% over the next twelve months while US bonds returned 8-9%.
How does cash compare?
Latest estimates indicate there is £430 billion in excess cash savings not invested by UK adults2. This level of cash savings can partly be explained by individuals receiving interest rates on their savings that they have not seen in 15 years. But what happens when central banks start to cut interest rates? We again looked at the past seven periods when rates were cut in the US to see how cash returns compared to other safe assets like US government bonds.
