Fed Rate Cut Began (1995) - Will 2024~25 Be Like 1995?

After Jerome Powell, the Chair of the Fed, stated at the Jackson Hole conference on Aug 23 that "the time has come for policy to adjust," prices of the S&P 500, NASDAQ, bonds, gold, and bitcoin all rose. (For reference, the Jackson Hole conference is a global economic policy symposium held annually in August in Jackson Hole, Wyoming, USA. Started in 1978, it can significantly influence financial markets such as stock indices and exchange rates by suggesting (sometimes new) directions for global economic policy.)

However, after Powell’s speech, stock prices quickly fell and then almost flattened. This is marked in the chart below with arrows. They then rapidly recovered, with the S&P 500 ending up 1.15% and the NASDAQ up 1.47%.

During the speech, the Fed Chair confirmed the rate cut next month. Why did the S&P 500 and NASDAQ give up all their gains, even if only momentarily? Was it because the Fed didn't hint at a 0.5% cut? Or were there market participants who think rate cuts might be bad for stocks?

The "Fed Rate Cut Begins" series aims to prepare for the upcoming rate cut cycle by examining how major asset prices have changed when the Fed ("the Fed" or "Federal Reserve") has started cutting rates in the past. You might have heard experts say that you should flee the market when the first rate cut occurs because past Fed rate cuts led to falling stock prices. However, now that a rate cut is imminent, it seems that experts' tones have become more positive. They often reference 1995 as a comparable case. So, let’s take a look at what happened in 1995.

Again, I will focus on the S&P 500 (U.S. large-cap stock index) and gold (spot) price. The points of reference are the price one month before the first rate cut, one month after the first rate cut, and one month, six months, and one year after the last rate cut.

First, let's review the timing and extent of the Fed's rate cuts in 1995.

On July 6, 1995, the Fed began cutting rates by 0.25%. This was followed by two additional cuts of 0.25% each, totaling a 0.75% decrease. As a result, the rate was adjusted down to 5.25% from 6.00%, which was the end of this mini-rate cut cycle. For reference, the next rate adjustment occurred on March 25, 1997, when the rate was increased by 0.25%. Prior to the first cut, the rate was raised to 6% on February 1, 1995, following a 3% increase over seven steps from February 4, 1994, to February 1, 1995.

This might be confusing, but that was typical of the Fed’s  unpredictable behavior at the time. In summary, they increased rates by 3% over a year to reach 6%, then cut rates by 0.75% to 5.25% within five months, raised it slightly by 0.25% after 14 months, and began lowering it again six months later. It seems like a series of inconsistent decisions. Alternatively, it could be viewed as fine-tuning based on economic conditions.

Let's briefly return to 2024. The Fed raised rates 11 times from March 2022 to July 2023, totaling 5.25%. If the Fed cuts rates in the coming weeks (Sept 18 to be exact), it will be the first rate change in 14 months. The current situation might differ somewhat from that of 1995 in terms of the magnitude and duration of prior rate increases. While the upcoming rate cut cycle might not be very large, many financial institutions expect rates to settle between 3.0% and 3.5% by the end of 2025. If this materializes, it would be a much larger cut compared to the 0.75% in 1995, though similar to the level of 6.0% versus 5.5% at the start of the cut cycle.

Why did the Fed start cutting rates in 1995? The reasons included concerns about a slowdown in economic growth, weakening inflation, and worries about the global economy (especially Japan and Europe). Since a recession hadn't yet hit the U.S. at that time, the cuts were considered "insurance." This seems somewhat similar to the current situation.

Now, let’s examine the S&P 500 during that time.

Compared to the reference date (one month before the first rate cut), the S&P 500 steadily increased after the rate cuts began. By the time of the last rate cut (January 31, 1996, eight months after the reference date), it had risen by 18.8%. It continued to climb and by one year after the last rate cut (one year and seven months after the reference date), it surged by 48.8%. Investors must have been very pleased.

Meantime, how did gold prices change?

Comparing the reference date to the day of the last rate cut, gold prices increased by 5.7%. Over about eight months, this translates to an annualized rate of 8.7%, which is quite decent. The problem came afterward. Gold prices gradually declined, and by one year after the last rate cut, they had dropped by -10.4% compared to the reference date. The relative return compared to the S&P 500 was -57.2 percentage points!

In the two cases previously examined, gold outperformed the S&P 500, especially in 2001. In contrast, the 1995 results were the opposite. One reason could be the difference in the extent of rate cuts: 0.75% in 1995 compared to 4.75% in 2001. In 2019, the cut was in between at 2.25%.

To summarize/generalize, when the rate cut was large like in 2001 (during an economic crisis or clear recession), stock indices fell significantly while gold prices rose. When the cut was small, like in 1995 (with less concern for a recession), stock indices rose significantly while gold prices fell. In the intermediate case of 2019 (again no recession), both stock indices and gold prices rose. While generalizing from only three cases may be risky, the patterns observed so far appear to be logically consistent.

Originally, I intended to select only two cases (1995 and 2001) to illustrate how stock markets performed well or poorly after Fed rate cuts. However, I added a third case (2019) to provide a more balanced view. What kind of case will the 2024–25 rate cut cycle be? No one knows for sure. Over time, when the results become clear, there will undoubtedly be people who say, "See, I told you so!" This happens not because they have a crystal ball to predict the future, but because when many people present various possibilities, some will inevitably turn out to be correct. Of course, some experts might draw more precise inferences based on extensive data sets. I am not one of them, instead I focus on probabilistic thinking.

I consider how my investment portfolio might be affected under different scenarios, assign approximate probabilities to each scenario, and decide how to manage my portfolio accordingly. Alternatively, I create 3-4 distinctly different portfolios and adjust the allocation according to changes in financial/economic conditions. In fact, I use both methods: the first method for my primary portfolio and the second for the other 2-3 auxiliary portfolios. I believe that scenario-based probabilistic thinking can be useful for everyone. With that, I will conclude the "Fed Rate Cut Begins" series.

Thanks for reading. Wish you grow rich slowly and surely!

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