Anticipated Rate Cuts and Potential Impacts

With the upcoming Federal Reserve rate cuts looming, investors are revisiting historical yearbooks and investment proverbs. Past experiences suggest that if easing monetary policy successfully boosts the U.S. economy – as indicated by rising stock and bond markets – most asset classes will benefit. However, a weakening dollar could bring unexpected twists. Investors are confident that the Fed will initiate its first rate cut since last December this week, by 25 basis points. Futures contracts indicate that the market anticipates a further cumulative reduction of approximately 75 basis points in the next six months. The stock market has already priced in this expectation: the S&P 500 index has repeatedly reached new highs and has not experienced a significant weekly decline since late July.

Historical Performance of Stocks After Rate Cuts

Historical patterns show that when the Fed resumes easing after a pause of several months and successfully avoids a recession, the S&P 500 index tends to perform strongly. Goldman Sachs data reveals that, over the past 40 years, the median gain for the S&P 500 one year after the Fed's first rate cut has been about 15%. Traditionally underperforming sectors include banks (where lower interest rates squeeze net interest margins) and insurance (where investment returns decline in parallel), while defensive sectors such as utilities and telecommunications typically outperform.

The Weakening Dollar as an Influential Factor

The difference this time is that the dollar is weakening. Last year, when the Fed first cut rates, the dollar and stocks rose simultaneously. But this year, even though stocks quickly shrugged off the impact of April's tariff disputes, the dollar has continued to decline. The dollar has depreciated by 10% against a basket of currencies since January, mainly due to rate cut expectations and the perceived risk to the Fed's independence. Many analysts predict that the dollar will fall further. The current market concern about a weaker dollar is dampening foreign investors' risk appetite. Although artificial intelligence (AI)-related stocks remain in demand, Bank of America points out that investors are shifting to an “Anything But the Dollar” (ABD) trading strategy, i.e., avoiding dollar-denominated assets and seeking other currencies or asset classes.

Emerging Markets as Potential Beneficiaries

Emerging markets may be the primary beneficiaries. If the Fed's rate cuts support U.S. economic growth, the outlook for emerging markets themselves will improve, and they are also cutting rates in parallel. Of the 21 emerging markets tracked by JPMorgan Chase, 19 have initiated easing cycles. For these countries, a weaker dollar means a rise in the value of their currencies, which will boost foreign investor confidence. Since the beginning of the year, the MSCI Emerging Markets Index has outperformed the S&P 500. Although previous forecasts of an emerging market recovery have often fallen short, the political pressure the Fed faces from the U.S. President, coupled with falling interest rates, further increases the likelihood of a depreciating dollar. And this, in turn, makes non-U.S. assets more attractive – whether the White House is happy about this outcome or not.