Chart of the week: Little by little

A client asked how markets perform when interest rates are cut.

Expectations have been building of a rate cut by the US Federal Reserve, particularly following the Jackson Hole symposium just over a week ago when policymakers, including Fed Chair Jerome Powell, signalled they were ready to act. Historically, markets have responded positively to rate cuts, but is the reaction likely to be favourable this time?

Why the Fed is considering cuts now: Previous rate-cutting cycles were in response to economic downturns or financial crises. However, the Fed's current situation is different. Inflation has cooled, with US core CPI down to 3.2% – the lowest since April 2021. Meanwhile, unemployment remains relatively low, but there are signs of a softening labour market. The Fed appears poised to ease its restrictive stance not to accelerate the economy, but to strike a balance as it adjusts to more neutral policy settings.

Market implications of rate cuts: Rate cuts generally provide a boost to financial markets. Stocks have historically performed well in the months following initial cuts, although the journey isn't always smooth. Investors can expect volatility, particularly as economic conditions shift and the market reacts to new data.

What's different this time: This rate-cutting cycle is expected to be more gradual. Rather than large, crisis-driven cuts, the Fed may opt for smaller, 25-basis-point reductions. This cautious approach is in response to a complex mix of moderating inflation and still-strong employment figures. As a result, market rallies might not be as sharp as in previous cycles, but the ongoing adjustments should support a more sustainable path for growth.

Key takeaway: Overall, the market's reaction to a potential Fed rate cut is likely to be positive, especially if the expected rate-cutting cycle is seen as a move toward a balanced policy rather than a response to a crisis. Investors should be prepared for opportunities and challenges as the Fed navigates this new landscape.

We see opportunities in small caps and infrastructure, which are sensitive to interest rates and likely to benefit from cuts. These are asset classes we’re reviewing. It’s worth noting that, through our single-strategy funds, Marlborough has real strength in these areas.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.