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Here's how the stock market tends to perform when the Fed cuts rates

MarketWatch logo MarketWatch 7/30/2019 Mark DeCambre

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Video by The Wall Street Journal

The Federal Reserve is widely expected to cut benchmark borrowing costs for the first time in more than a decade Wednesday afternoon — but can a reduction in rates help improve Jerome Powell’s less-than-stellar stock-market record?

Investors are pricing in a roughly 78% chance of a quarter-of-a-percentage point reduction to a range of 2%-2.25% from 2.25%-2.50%, with the chances of a half-a-point cut holding at around 22% based on federal-funds futures, according to CME Group data.

In other words, the likelihood of a cut of some magnitude is statistical very high, while the only key unknown is how the stock market might react to the 2 p.m. Eastern Time policy decision and the following Q&A hosted by Federal Open Market Committee Chairman Jerome Powell.

The 66-year-old Fed boss has a losing record on Wall Street as it pertains to the market’s reaction to Fed’s statements and his words. He has had two winning days out of the past 11 meetings, with the only positive gains for the market coming in January when policy makers paused a string of rate increases, MarketWatch’s William Watts has noted, and last month when Powell & Co. set the stage for what is shaping up to be a likely rate cut in 24 hours.

Check out: Five things to watch from this week’s crucial Fed meeting

However, this time may be viewed as different, with the market’s bracing for the first rate cut after the FOMC popped off a run of nine rate hikes beginning at the end of 2015.

So, how does the market tend to perform in a rate-cut regime?

First the good news: Markets, as would be expected, tend to rally after rate cuts, because those policy actions translate into lower borrowing costs for individuals and corporations and tend to support higher moves for stocks.

a screenshot of a video game: S&P 500 usually pops after cuts S&P 500 usually pops after cuts

In fact, since 1990, the S&P 500 has gained on average 0.16% on the day of a 25-basis-point cut. One-month later, the broad-market benchmark is 0.57% higher. Double that cut and the market is 0.34% higher on the of the decision day and 1.25% higher a month later. A 75-basis-point reduction has resulted in a powerful 2.76% rally on average but 0.27% gain in the following 30-day period.

That brings us to the bad news (and partly good news), the greater the magnitude of the rate cut, the weaker the returns over the coming three and six months. However, a quarter-of-percentage point has tended to be a Goldilocks number, resulting in an average return of 3.67% three months later and 5.64% in six months.

Cuts of 50-basis points and greater all resulted in losses in the coming quarter and half-year period, as the following table shows:

Rate cutsDay ofOne month later3 months later6 months later
25-basis-point cut0.16%0.57%3.67%5.64%
50-basis-point cut0.34%1.25%-1.36%-3.58%
75-basis-point cut2.76%0.27%-3.97%-4.01%

Part of that may be that sizable cuts also have coincided with economies that were in need of help. This rate cut is one that is being billed as a so-called insurance cut, with the Fed hoping to mitigate the harm of a longstanding trade dispute between China and the U.S. that Powell has described as creating “cross-currents” in markets and the economy.

The fact that a more modest cut has had a more lasting impact on markets may be worth noting, given the degree to which investors, including President Donald Trump, have been clamoring for sizable monetary-easing measures.

The stock market has had a brisk run-up thus far, ahead of the anticipated monetary-policy action. The S&P 500 (SPX) has gained 20.2% so far in 2019, the Dow Jones Industrial Average (DJIA) has returned 16.6% over the seven-month period, while the Nasdaq Composite Index (COMP) is on track to gain 25% over the same time.

Those hefty gains have raised some questions about how much further stocks can rally.

Check out: Goldman raises its 2019 target for S&P 500, projects another 10% rise in 2020

—Ken Jimenez contributed to this article

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