Snapshot

How do US markets react to emergency interest rate cuts?

The US Federal Reserve (Fed) unexpectedly cut interest rates by 50 basis points (bps) on 3 March. This was done to try to support the economy amid the threat to activity posed by coronavirus.

Similarly, the Bank of England made an emergency cut to rates on 11 March, also in response to the coronavirus impact.

But how do such rate cuts affect markets?

We look at previous instances where the Fed has stepped up to deliver an emergency cut following a severe market event.

In the past 30 years, US policymakers have intervened six times, delivering an initial interest rate cut of between 25 bps and 75 bps (see table below).  

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It’s worth noting that in all past cases in the US, the rate-cutting process did not stop with the emergency meeting. The Fed actually followed through with further easing at the next scheduled meeting.

Our table above also details what stage of the economic cycle we were at when these cuts took place (see US output gap and Global wave columns). The latest cut is the first to take place when both our sets of models were signalling expansion.

While we recognise that each past event had different drivers leading to the emergency ease, we believe it’s informative in this context to look at the performance of US shares (as represented by the S&P 500) and US 10-year bond yields in the period before and after each emergency cut.

The period we’re looking at is 20 days before the emergency cut and 40 days after.

US equities were on average already in drawdown in the month prior to the meeting, then stayed range-bound in the month after the meeting.

Following the cut on 3 March, US shares experienced meaningful intraday volatility (a range of approximately 5%). This is consistent with what has happened on each of the prior occasions.

Performance of S&P 500 before and after emergency rate cuts

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Turning to bond markets, US 10-year yields on average rose (i.e. prices fell) in the 10 days following the cut, but by a very small magnitude. However, in the two months following the easing move yields did move lower (meaning prices rose), albeit at a different magnitude in each occasion.

US 10-year Treasury yields before and after emergency rate cuts

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This analysis suggests that while each of the emergency rate cuts discussed above was driven by specific market conditions, the common denominator is the Fed’s reaction. Looking at past events, we are likely to see further easing in the near future and continued volatility in the equity market.

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