Does It Matter How Many Times the Fed Cuts Rates in 2024?
In my column last week, I wrote that the end of ‘synchronized global monetary tightening’ could mean the dissipation of a key headwind for stocks. I deliberately did not frame the end of the tightening cycle as a tailwind—stocks’ performance depends on too many other factors, like earnings growth, expectations for economic growth in the year(s) ahead, investor sentiment, geopolitics, and so on.1
This brings me to the question I’m addressing this week: Does it matter how many times the Fed cuts rates in 2024, or if they even cut rates at all?
We know from December minutes that the Federal Reserve is projecting the benchmark fed funds rate will end 2024 in a range of 4.5% to 4.75%, which seems to imply three 25-basis-point cuts sometime this year. As of last week, the market (via futures contracts) is betting the Fed will deliver five 25 basis-point-cuts. This disconnect has many investors worried. What happens to stocks if the Fed underdelivers?
The answer often given is that fewer than expected rate cuts—or worse, no cuts at all—would end the bull market and result in an economic recession. Monetary policy works on a lag, so I think there’s some fairness to the recession argument. Keeping rates too high for too long could result in sustained funding pressure for banks, since deposit rates would need to move steadily higher. This hasn’t been a problem for banks yet—national average savings deposit rates are well below the effective Fed funds rate (0.46% vs. 5% to 5.25%), but eventually, banks will increasingly need to compete for deposits, driving those rates higher. Net interest margins shrink when deposit rates rise closer in line with long rates, which can choke off lending and by extension economic activity and investment. I’m not convinced this is a 2024 issue, however, given that banks (especially large ones) are flush with deposits.
So, what about the bull market?
My thinking goes back to a topic I wrote about last year when I tested the potency of the “Don’t fight the Fed” mantra. Over the past few years, I’ve seen financial media focus more and more on the role the Fed plays in determining stock market returns, and I continue to believe the correlation is not only misguided, but also misleading.
History tells the story. To start, two of the last three rate-cut cycles (2000-2003, 2007-2008) coincided with falling stocks. A third rate cut cycle, which started in 2019 and unexpectedly went into overdrive in 2020 with the pandemic, did not. Looking back even further, Fed cuts in the mid-1980s corresponded with positive stock returns, but the rate cuts from mid-1989 to 1992 aligned with a volatile period that included a bear market.
On the flip side, recent history proves that stocks can do well even as the Federal Reserve is engaged in monetary policy tightening. As seen in the chart below, the Fed was raising rates steadily from 2016 to 2019, and stocks went up almost 30% over that period. Then, in October 2022, a new bull market began even as the Fed was aggressively raising rates and telegraphing its “higher-for-longer” stance on monetary policy.
Effective Federal Funds Rate, 2014 – Present
In short, there just isn’t enough historical evidence—via the correlation between rate hikes/cuts and stock market performance—to say that it’s all riding on the Fed in 2024. Too many other factors matter, too.
Bottom Line for Investors
As I’ve written a few times recently, I’m not arguing that monetary policy decisions are meaningless to stock market performance. Interest rate hikes and/or cuts are key factors determining financial conditions and the outlook for earnings and growth, which in turn makes them a critical factor driving stock prices.
The point I’ve been making recently, however, is that monetary policy isn’t the only factor driving stock returns, and the Fed doesn’t have make-or-break power over the stock market. At the end of the day, a strong fundamental economy and rising earnings matter far more than two, three, five, or zero rate cuts in the new year. History tells us as much.
Disclosure
2 Fred Economic Data. January 22, 2023. https://fred.stlouisfed.org/series/DFF#’’
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