The third strike seemed to be just what the market needed Wednesday.
After the Federal Reserve decided to cut interest rates for the third time this year, the stock market soared, with the S&P 500 even jumping to a new all-time high just two days after it reached its previous record.
But it was Fed Chairman Jerome Powell’s comments after the decision that were the interesting part.
There were some on Wall Street who were already anticipating another quarter-point cut at the central bank’s December meeting, but Powell hinted that the market shouldn’t expect another rate cut in the near term when he said that the committee believes “monetary policy is in a good place now. There’s plenty of risk left, but I’d have to say that the risks seem to have subsided.”
Historically, when the Fed cuts rates three times and then pauses like it is now, it’s usually a very good sign for stocks.
Each time the Fed has cut rates three times over the last 25 years, when the third rate cut has been the last, stocks have performed well over the next year. When the third cut was followed by more cuts? Stocks usually fell because the economy was on its way to a recession.
For this week’s FOMC meeting, the committee removed a key clause that has appeared in its post-meeting statements since June that said it was committed to “act as appropriate to sustain the expansion,” and instead replaced that statement with its commitment to “monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate.”
Powell also said in his presser following the decision that central bank officials “see the current stance of monetary policy as likely to remain appropriate.”
“We’ve seen periods of economic slowdowns that had three consecutive 25 basis point cuts, most recently in the mid-and late 1990s,” said LPL Financial senior market strategist Ryan Detrick. “The good news is the economy accelerated after the slowdowns and stocks did quite well.”
Detrick was referring to the Alan Greenspan era between 1995 and 1996 and in 1998, when the Fed cut interest rates three times and then stopped in an effort to thwart an economic downturn and sustain the economic expansion. In those cases, the S&P 500 returned 24.76% and 19.39%, respectively, over the following year.
Evercore ISI Chairman Ed Hyman called this three-cut strategy the “magic sauce in the 1990s to get growth to stop slowing.” In fact, the 1998 expansion ended up being the second-longest expansion in history, behind the one we’re in now.
Greenspan, for his part, says that it’s too soon to start betting on a U.S. recession now as business are still borrowing.
“The economy has been weakening, but we’re still in a period of deleveraging,” Greenspan said. “No recession in the last half century, at least, began from a period of deleveraging.”
“I’m cautious about the long-term outlook, and we’re currently running under 2% real GDP annual growth rate, but we nonetheless don’t appear to be sinking into recession despite the fact that economic growth has slowed significantly,” the former Fed chairman continued.
If the Fed does end up needing to issue another rate cut, hold on to your hats as it likely won’t be a good sign for the economy.
In 2001 and 2007, or the dotcom bubble and the beginning of the financial crisis, the Fed cut interest rates three times and kept cutting to try to jumpstart the economy. In those cutting cycles, the S&P 500 sank -12.64% and -42.37%, respectively over the following year.
If the historical data is any guide then, hoping for another rate cut now is tantamount to hoping for a recession over the next year.