Federal Reserve interest rate cuts = Surge in US stocks? There is an important premise and key indicator
Barclays stated that the performance of the U.S. stock market after the Federal Reserve cuts interest rates completely depends on the important premise of whether the economy falls into recession. Research shows that in the past 50 years, during the seven interest rate cuts, the stock market steadily rose without a recession, with a 12-month increase of 17%; however, in the case of a recession, the stock market continued to decline, with an increase of only 6%. The unemployment rate is a key indicator that distinguishes the two scenarios: during a recession, the unemployment rate continues to rise for nearly a year, while during an expansion, it rises slightly before falling back. Currently, the U.S. unemployment rate has risen to 4.3%, becoming a key factor for the Federal Reserve to consider cutting interest rates
After the Federal Reserve cuts interest rates, will the US stock market surge? Barclays points out that this crucially depends on whether the economy falls into recession, with the unemployment rate being a key indicator for assessing economic direction and determining stock market performance after rate cuts.
On September 11, according to news from the Chasing Wind Trading Desk, Barclays stated in its latest research report that historical experience shows that stock performance entirely depends on whether the economy falls into recession after the Federal Reserve restarts rate cuts. Research indicates that in the past fifty years, among the seven instances where the Federal Reserve significantly paused and then restarted rate cuts, four were accompanied by economic recession, while three saw continued economic expansion, leading to vastly different stock market performances in both scenarios.
The report states that the market generally expects the Federal Reserve to restart the rate-cutting cycle next week, with market pricing indicating about six rate cuts over the next 12 months. In the absence of recession, the stock market steadily rises after rate cuts and reaches new highs within six months, outperforming bonds. However, if a recession occurs, the stock market typically continues to decline after rate cuts, although it rebounds after 12 months.
Barclays emphasizes that the unemployment rate is a key indicator distinguishing between the two scenarios (economic recession or economic expansion). Historical data shows that when a recession occurs, the unemployment rate continues to rise for nearly a year after rate cuts; whereas during periods of sustained economic expansion, the unemployment rate only rises slightly before beginning to decline within a few quarters. Currently, the US unemployment rate has been steadily climbing, which is a key factor prompting the Federal Reserve to consider rate cuts.
In addition, the bank also stated that the shape of the yield curve affects sector performance. Historically, a flattening environment in a bull market is most favorable for the stock market, while cyclical sectors perform best during a steepening in a bear market. Barclays believes that if current interest rate pricing remains unchanged, the bull market flattening trend may continue and continue to support the stock market.
Historical Review: Stock Market Performance After Rate Cuts Depends on Recession or Not
According to Barclays' statistics, in the past fifty years, among the seven major instances where the Federal Reserve significantly paused and then restarted rate cuts, four rate cuts in December 1974, November 1981, July 1990, and October 2008 were followed by recessions, while three rate cuts in December 1995, November 2002, and June 2003 were followed by sustained economic expansion.
In the absence of recession, the average performance of the MSCI World Index one month, three months, six months, and twelve months after rate cuts was 1%, 2%, 8%, and 17%, respectively. In contrast, the performance during recession scenarios was -2%, 2%, 0%, and 6%, which is significantly inferior.
Cross-asset performance also shows differentiation. In the absence of a recession, stocks typically outperform bonds, with the S&P 500 index achieving a 12-month performance of 16%, while the 10-year U.S. Treasury yield remains nearly flat. In a recession scenario, bonds perform better, with U.S. Treasury yields rising by 8 percentage points, while the S&P 500 index's 12-month increase is only 12%.
It is noteworthy that if the economic cycle ultimately continues, the stock market usually rises before a new round of interest rate cuts, but the reverse is not true. This indicates that market expectations for the economic outlook are already reflected before the initiation of interest rate cuts.
Unemployment Rate: A Key Indicator Distinguishing Soft Landing from Recession
The trend of the unemployment rate has become a key variable in judging the economic path after interest rate cuts. Historical data shows that in a recession scenario, the unemployment rate continues to rise for about a year after interest rate cuts, with a cumulative increase of 2-3 percentage points. In contrast, during a sustained economic expansion, the unemployment rate only rises slightly around the time of interest rate cuts and then begins to decline within several quarters.
Currently, the U.S. unemployment rate has steadily risen from a low of 4.3%, which is the main driving factor behind market expectations for the Federal Reserve to restart interest rate cuts. Barclays economists expect that as the labor market significantly slows down, the Federal Reserve may lower the federal funds rate from the current level to 3.0% by the end of 2026.
Leading indicators in the job market suggest that wage growth may further slow down. Leading indicators such as the ISM employment index indicate that the momentum of job growth will continue to weaken, but the U.S. economic surprise index remains strong and positive, contrasting sharply with the sharp downward adjustment in interest rate expectations.
Economic activity indicators also show a similar pattern. The ISM manufacturing index typically begins to improve about a quarter after interest rate cuts in the absence of a recession. However, in a recession scenario, this index continues to decline for several quarters before bottoming out and recovering.
Yield Curve Shape Determines Sector Rotation Direction
Different shapes of the yield curve have a significant impact on stock market sector performance. Historical data shows that the yield curve between the 10-year and 2-year U.S. Treasury yields typically steepens before interest rate cuts, and this trend is more pronounced in a recession scenario.
After the restart of interest rate cuts, the yield curve shows differentiation. In the absence of a recession, the curve gently steepens within several months after the rate cut and then flattens. In a recession scenario, after an initial steepening, a bear market flattening occurs, which then transitions to a bear market steepening about six months later as the economy recovers.
From the sector performance perspective, the bull market flattening environment is most friendly to the stock market, with the overall market showing the largest increase and broad participation across sectors, slightly favoring cyclical sectors. Cyclical sectors perform best during bear market steepening periods, while they perform poorly during bear market flattening and bull market steepening periods.
Currently, the decline in real interest rates in the United States is the main factor driving yields lower, rather than changes in inflation expectations. Historically, a decline in real interest rates is usually beneficial for short-cycle sectors such as capital goods, durable consumer goods, chemicals, building materials, automobiles, mining, and transportation
