Considerations for Portfolio Positioning Given the Fed is Signaling a Rate Cut.
The Federal Reserve has sent clear signals: The era of interest rate hikes begun in March 2022 is over and it’s time to start cutting rates. Investors are parsing through the Fed’s signals and economic data to see how much of a rate cut to expect at the next meeting. Investors may want to consider if their portfolios are positioned for a new rate regime, or if adjustments should be made.
Unique Factors
While historical analysis suggests that the best time to position for a rate cut is in the months leading up to it, the potential for a rate cut later this month is a bit unique for two reasons. September is seasonally one of the weakest months for stock market returns and it’s an election year. Volatility in the equity markets is typically higher heading into an election. All these factors coinciding may present a unique opportunity for investors across a variety of asset classes.
The Coming Regime Shift?
The Federal Funds Rate has held steady this year at its highest level since 2001. The Fed began raising it in March 2022 to bring down high inflation and with the goal of engineering a “soft landing” of the economy, where growth slows, but the economy does not slip into a recession.
There are basically two main reasons the Fed may start cutting rates:
Although the amount of the cut is still uncertain, it seems that they are likely to begin in the coming weeks.
Implications: What History Tells Us
In general, what investors consider higher quality assets – for example, U.S. Treasuries, the classic safe haven during economic turmoil, as well as value stocks, considered to be more stable companies --perform best in the periods leading up to and following a rate hike. As the chart below demonstrates, those asset classes outperform their competitors in the three months leading up to, and following, a rate hike.
Notably, most of this outperformance occurs before the initial rate cut, as investors begin to respond to expectations of lower rates. Investment grade bonds also perform well, which are similarly considered more stable.
It’s worth mentioning, however, that historically there is follow-through on asset class performance after the first rate cut, most notably in large cap equity but also across fixed income.
Over a slightly longer time frame of six months before and six months after the first rate cut, the performance differences become even more pronounced. Historically, as the chart below shows, 10-year U.S. Treasuries have returned nearly 16% over that period, while value stocks and investment grade bonds rose roughly 10%.
To be sure, no one can guarantee what happened in the past will reoccur. However, there’s an old saying that history doesn’t repeat itself, but it often rhymes. In the past, when the signals were flashing that a rate cut was coming, investors responded by repositioning their portfolios. It may well be time to consider similar steps.
Past performance is no guarantee of future results.