Trading techniques... interest rates

The US Federal Reserve meets in early May to decide on the direction of interest rates. Many analysts think there may be one more interest-rate hike in the next few months, but no more after that; rates could even start to come down later this year. In theory an interest-rate cut should be good for markets as it will reduce companies’ borrowing costs, while making bonds relatively less attractive than shares. An interest-rate reduction could also prompt consumers to spend, boosting GDP, at least in the short run.

However, things are a little more complicated. For instance, a cut (or a hike) may have already been anticipated by the markets, and therefore priced into the price of shares by the time it appears. Note, too, that since 1977 the Fed has been under a mandate to promote “maximum employment” as well as stable prices. This means a cut in rates could be seen as bearish if it means the Fed is worried that the US economy is slowing. Even though the US Federal Reserve cut rates from 5.25% in September 2007 to a range between 0% and 0.25% in December 2008, the market crashed by 40% during this period.

Studies are similarly contradictory. Advisory and brokerage firm Strategas found that buying when the Fed starts to cut rates, and then selling when rates begin to rise, would have made you an average annualised return of 20% between 1982 and 2015. A 2010 inquiry found that between 1989 and 2009, an unexpected cut to US interest rates boosted the stockmarket by an average of 4% the next day. But after the 17 rate cuts between the start of 2000 and the end of 2022, the S&P 500 produced an average negative return of 1% over the following three months.