Fed Rate Pauses - Not What You Think?
Publication Date: December 4th, 2023
Following the US Federal Reserve’s rate pause on November 1st, equity markets rallied – the pause considered a welcome relief from further monetary tightening. Indeed, November’s rally is not inconsistent with initial equity market optimism following previous pauses in rate hikes.
What does history tell us about the ensuing months following a rate hike pause and equity market rally? Stock market performance following the last two pauses in rates hikes above 5% may not be what you expected.
It has happened just a few times since the 1981 peak in rates. Consider the last two times: In June 2000 interest rates peaked and the Fed held rates steady for 6 months. The S&P 500 initially rallied, peaking in September 2000, and then experienced a 46% peak to trough decline through the lows in February 2003. Trend-following CTAs on the other hand delivered 49% over the same period. See Table 1 below.
Source: Auspice Capital Advisors, Bloomberg, and FRED Economic Data
The most recent pause above 5% was July 2006. The S&P 500 again advanced following the rate hike pause, only to correct 53% peak to trough through the lows in February 2009. Trend-following CTAs on the other hand delivered 28% over the same period. See Table 2 below.
Source: Auspice Capital Advisors, Bloomberg, and FRED Economic Data
As Chair of US Federal Reserve Jerome Powell has indicated, it takes time for higher rates to work through the economy[1]. In Canada for example homeowners are just beginning to feel the impact of higher mortgage rates. In 2024 and 2025, an estimated 2.2 million mortgages will be facing interest rate shock, representing 45% of all outstanding mortgages in Canada[2]. Most of these borrowers contracted their fixed-rate mortgages at record-low interest rates and, most likely, at or near the peak of housing prices around 2020 – 2021[3].
Only time will tell whether equities hold on or sell off as they did following the previous two pauses. As it has been suggested in the media, “maybe this time is different”. Some diversification however, for example trend-following CTAs, could prove beneficial.
For information about the Auspice product suite and how we can help, email us today at info@auspicecapital.com.
DEFINITIONS
· The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. Price Return data is used (not including dividends).
· The Barclay BTOP50 CTA Index seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. The BTOP50 employs a top-down approach in selecting its constituents. The largest investable trading advisor programs, as measured by assets under management, are selected for inclusion in the BTOP50. The index does not encompass the whole universe of CTAs. The CTAs that comprise the index have submitted their information voluntarily and the performance has not been verified by the index publisher.
· The federal funds market consists of domestic unsecured borrowings in U.S. dollars by depository institutions from other depository institutions and certain other entities, primarily government-sponsored enterprises. The effective federal funds rate (EFFR) is calculated as a volume-weighted median of overnight federal funds transactions reported in the FR 2420 Report of Selected Money Market Rates. The New York Fed publishes the EFFR for the prior business day on the New York Fed’s website at approximately 9:00 a.m.
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[1] https://www.federalreserve.gov/newsevents/speech/powell20231201a.htm
[2] https://www.cmhc-schl.gc.ca/blog/2023/rising-rates-homeowners-greatest-shocks-lie-ahead
[3] https://www.cmhc-schl.gc.ca/blog/2023/rising-rates-homeowners-greatest-shocks-lie-ahead