Fed Rate Cut Began (2019) - What Happened?

The U.S. central bank (Federal Reserve, hereafter "Fed") is poised to cut interest rates within this month (to be exact, 18 Sep 2024). As an investor, I’m both curious and nervous about how major asset prices will react if the much-anticipated Fed rate cuts, which have been rumored since last year but finally it is about to become a reality.

Logically, a rate cut should be favorable for asset prices, including stocks, as asset valuations are fundamentally based on the present value of future cash flows, with interest rates being a key factor in calculating these values. Of course, for assets like gold or bitcoin, which do not generate cash flows, the analysis differs, but if we view interest rates as the value of money, it makes sense to assume that a drop in interest rates, and hence a decrease in the value of money, would increase the relative value of gold or bitcoin (to be precise, it is “real interest rates” (nominal interest rates - inflation rates), which set the value of money.)

However, why do many economic and financial experts warn that stock prices might fall if the U.S. cuts interest rates? For a while, more experts seemed to be saying this, but recently, it feels like more are suggesting that this time might be different, and stock prices might actually rise with a rate cut. (According to Sir. John Templeton, the four most dangerous words in investing are: “this time it's different” which is why studying and understanding past cases is essential.) Regardless, there seems to be consensus that a rate cut is a significant market-moving event.

Individual investors need to stay sharp during times like these. Since no one has a crystal ball to predict the future, the best approach is to reference past events that are most similar to the current situation. Examining cases from too far in the past might not be helpful due to changes in the global economic structure and the Fed’s response mechanisms. (For example, before 2008, the term “quantitative easing,” which we are now very familiar with, didn’t even exist as a Fed policy. Now, quantitative easing and even quantitative tightening are key tools for the Fed. The Overnight Reverse Repo Program (ON RRP), for instance, was only widely used starting in 2013.) Therefore, I aim to focus on examples from the last 30-40 years.

At first, I set aside the 2019-2020 cycle as a special case due to the sharp rate cuts prompted by the Covid-19 pandemic. However, upon closer inspection, it seems that the 2019 rate cuts might offer important lessons, so I’ve decided to discuss it first. I believe 2019 and 2020 should be analyzed separately. In the U.S., Covid-19 only started to raise concerns around February 2020, with rate cuts following in March 2020 due to the pandemic. When the Fed cut rates in August 2019, Covid-19 pandemic was not even imagined. From August 1 to October 31, 2019, the Fed cut rates three times by a total of 0.75%, mainly due to slowing economic growth. Concerns about the deepening trade conflict with China, a disinflationary trend, and an inverted yield curve were also significant factors. This was a preemptive (or so-called insurance) rate cut to ward off a potential recession. 

Doesn’t this seem somewhat similar to the current economic situation? Notably, five months after the 2019 mini rate-cut cycle ended, the pandemic led to rapid rate cuts, bringing interest rates to near zero. Many experts are predicting a relatively modest rate-cut cycle from September 2024 through next year. Besides, on August 14, 2024, the World Health Organization (WHO) declared a public health emergency for Mpox, and a new wave of Covid-19 has begun. However small the likelihood of a health crisis similar to 2020, its probability appears to have ticked up very slightly.

Let’s start by looking at the timing and magnitude of the Fed’s rate cuts in 2019. I’ve also included the 2020 rate cuts for reference but in my opinion, the rate cuts of 2019 and 2020 should be viewed separately.

Now, let’s examine how major asset prices reacted following the Fed rate cuts. The assets under analysis include the S&P 500 (a major U.S. large-cap stock index), gold (spot), and bitcoin (the leading cryptocurrency). The timeline for analysis is as follows: 1 month before the first rate cut, 1 month after the first rate cut, and 1 month, 6 months, and 1 year after the final rate cut. However, for 2019, I will analyze the periods 1 month, 2 months, and 3 months after the final rate cut instead, as extending the analysis beyond 4 months would interfere with the subsequent rate-cut cycle triggered by the pandemic.

First, let’s look at the changes in the S&P 500 index, the leading U.S. large-cap stock index. Even if you primarily invest in non-U.S. markets, the influence of the S&P 500 is so significant that investors often closely monitor its movements overnight.

The Fed's preemptive rate cut to combat economic downturn fears ultimately led to a significant rise in the stock index. From early July to the end of October 2019, during the brief four-month rate-cut period, the S&P 500 initially moved sideways but then gradually rose after the final rate cut, increasing by 8.5% three months later. Of course, this stock rally was soon shattered by the Covid-19 crisis, which was followed by a huge stock market crash in a short period of time, and then an unprecedented rally.

What about the price of gold, which I’ve been particularly fond of lately?

After the first rate cut, gold prices rose by 9.1% within 1 month, which means it took just two months to achieve this gain. Afterward, gold experienced a slight decline but rebounded, rewarding patient investors with a 12.1% gain three months after the final rate cut in late January 2020.

Finally, let’s check bitcoin prices.

Despite the Fed's rate cut, bitcoin’s price declined sharply. Compared to one month before the first rate cut, bitcoin had fallen by 15.5% by the time the final rate cut occurred (four months later). This decline continued, and by the end of 2019, bitcoin had dropped by 33.2%. Concluding from this that U.S. rate cuts lead to bitcoin price declines would be a textbook example of flawed reasoning. If we look at the three halving cycles so far, bitcoin has typically surged during the halving year (2016) and the following year (2017). The aftermath often led to a crash in the +2 year (2018), followed by a recovery starting the next year (2019). In fact, bitcoin prices nearly doubled in 2019, rising by about 95%, although the period covered in the table reflects a phase of corrections. During this time, bitcoin's volatility was far more extreme than it is now. Bitcoin’s price was more influenced by its internal cycle than by the modest 0.75% Fed rate cut. In 2020, bitcoin showed an extraordinary 300% annual gain, fueled by the zero-interest-rate environment during the Covid-19 pandemic.

That concludes the 2019 analysis. I considered discussing the 2007-08 rate cuts next, but given that the extreme shocks of the Global Financial Crisis seem unlikely to recur in 2024-25 based on current economic indicators (or so I hope..), I’ve decided to exclude that period for now. Although I also considered excluding the 2001 rate-cut cycle due to the unique context of the dot.com bubble burst, I’ll cover it anyway, as ignoring all the negative examples would leave only positive bias in the results. Moreover, with AI bubble concerns currently on investors’ minds, the 2001 example seems particularly relevant.

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

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