Fed interest-rate cuts could boost stocks, or sink them. Here's what history says.

By Joseph Adinolfi

Whether or not the central bank can avert a recession in time will make all the difference

A Federal Reserve interest-rate cut on Wednesday is looking all but certain. How stocks might react as the central bank loosens monetary policy, however, remains very much up in the air.

History offers some guidance: the reason the Fed is cutting interest rates matters far more for markets than the simple fact that borrowing costs are coming down.

A chart from Vickie Chang, a macro strategist at Goldman Sachs Group, shows that since the mid-1980s, the Fed has eased monetary policy 10 times.

Four of these cycles have been associated with recessions; six were not. When the Fed succeeded in staving off a recession, stocks tended to rally. When it didn't, stocks tended to slide.

Investors likely won't have all the information they need come Wednesday. How stocks respond will depend on what the data show during the months ahead.

"Whether this cutting cycle will ultimately be a 'growth scare' or a 'recessionary' episode is the major market question," Chang said in the report.

Recessionary rate-cutting cycles saw the S&P 500 index SPX fall 10% during the first six months, according to the median case.

What will Wednesday's cut tell investors about the economy?

Still, the size of Wednesday's cut could go a long way toward shaping investors' perceptions about the economy, potentially setting the tone for markets for the rest of the year.

Investors are particularly hungry for more guidance nowadays, partly because the latest U.S. economic data have been somewhat ambiguous. Reports from the Labor Department have shown that hiring has slowed, while more workers have entered the workforce.

But layoffs haven't really picked up, at least not yet. Meanwhile, inflation has receded, although the latest data released this week hinted at some lingering stickiness when it comes to prices of key services, like rent and housing costs.

Investors' faith in the economy has helped propel stocks higher in 2024, but recently, that trust has been shaken.

At times, concerns that a rise in unemployment might snowball have overwhelmed stocks, helping to produce painful selloffs in August and September.

Has the Fed fallen behind?

Some believe that the Fed has already fallen behind the economic cycle and should have cut interest rates in July. For this very reason, many on Wall Street expect that a 50 basis point rate cut would likely elicit a negative reaction in the stock market.

Expectations for a 50 basis-point or half percentage point rate cut made a comeback on Friday. By the time markets closed, the size of next week's cut appeared to be a virtual coin flip, according to data from CME Group.

"Coming in hot with a 50 [basis point cut] means that they [the Fed] made a mistake in July, and that they're behind the curve, or that they have data that is worse than what we're seeing," said Shannon Saccocia, chief investment officer at Neuberger Berman Private Wealth, during an interview with MarketWatch.

"That would be more disruptive to the equity market in particular."

See: Bets on a big Fed rate cut just won't die. What stock-market investors need to know.

This uncertainty could set stocks up for an initial selloff, regardless of what the Fed does, according to a team of strategists at Deutsche Bank. The team said that, as of early Friday, the Fed was likely to surprise the market by the widest margin in 15 years, regardless of its choice.

In addition to the size of the cut, the latest batch of economic projections released by the Fed should be heavily scrutinized.

John Velis, currency and Macro Strategist at BNY, said in emailed commentary that it's extremely likely the Fed will need to raise its forecast for the unemployment rate, while downgrading its view on GDP growth.

This wouldn't necessarily mean the central bank expects a recession, he said. But it's still something investors should watch out for, as it could impact how deeply markets see the Fed cutting rates.

On the cusp of a legendary accomplishment

Although the data have yet to show any signs of an outright recession, investors have reason enough to be worried.

Achieving a soft landing for the economy after such a pronounced bout of inflation would be a legendary feat for Fed Chair Jerome Powell. According to Diane Swonk, chief economist at KPMG U.S., such an accomplishment would be unprecedented.

While the powerful bout of post-pandemic inflation has injected a new wrinkle, the Fed has managed to steer the economy back from the brink before.

A series of rate cuts that started in 1995 was one example where the Fed managed to pull off a "mid-cycle adjustment" without harming markets, according to Jurrien Timmer, director of global macro at Fidelity.

"It's the exception rather than the rule. But it can happen," Timmer told MarketWatch during an interview.

U.S. stocks finished sharply higher on Friday as the S&P 500 and Nasdaq Composite COMP climbed for a fifth straight day. Both indexes tallied their biggest weekly percentage-point gains since November 2023, according to Dow Jones Market Data.

Meanwhile, the Dow Jones Industrial Average DJIA clinched its best week in about a month.

The Fed's two-day September policy meeting is slated to begin Tuesday. Its interest-rate decision will be released at 2 p.m. Eastern Time on Wednesday.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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09-16-24 0428ET

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