Last week, the Federal Reserve sent out hawkish signals, leading the market to anticipate a pause in rate cuts in JanuaryThis development raises important questions about the implications for major asset classesA report released on December 19 by Dirk Willer and his team at Citi's Global Macro Strategy delved into the historical performance of macro assets during periods of pauses in easing cycles, differentiating between mere pauses and the end of easing cycles.
Citi's findings indicate that typically, U.Sequity markets tend to perform well during these pauses; however, the sustainability of these gains hinges on whether economic weakness will prompt a resumption of policy easingMeanwhile, bond yields generally rise either when the cycle pauses or definitively endsAs for the U.Sdollar, its performance fluctuates significantly; if a rate cut is merely paused, the dollar often remains stable, but if it marks the end of rate cuts, the dollar tends to strengthen
Gold, intriguingly, usually sees price increases regardless of whether easing continues after a pause.
In the short term, this environment appears favorable for U.Sequities, but the longer-term outlook remains uncertain as it depends on whether easing may be resumedAccording to Citi, risk assets generally perform better during Fed pauses or when the easing cycle is concludedHowever, the durability of these rebounds is contingent upon whether indicators of economic weakness compel policymakers to initiate further easing measures.
Specifically, regarding the performance of the S&P 500 index during such pauses, stocks may rise initially but tend to be sold off roughly a month later, typically due to deteriorating economic data that exerts downward pressure on stock pricesIn contrast, should the pause be confirmed as the final rate cut, the rebound in U.Sequities can turn more persistent, although returns might vary considerably
- Dollar Retreats, Oil Prices Rebound
- The Downfall of Japanese Automotive Giants
- Slight Decline in the Dollar Index
- Dollar/Yen Hits Five-Month High
- Embrace Change with Patience
Historical data reveals that the S&P 500 experienced a brief rebound of about 10% during the 1989 pause before pulling back, whereas rebounds following the end of easing cycles in 1998 and 2003 lasted upwards of three monthsOverall, Citi believes that the data support a constructive outlook for equities, at least in the short term.
On the flip side, the perspective on U.STreasury bonds is considerably less encouragingAccording to the report, typically, the pause in rate cuts is associated with climbing yieldsEarly stages of a pause tend to trigger a more significant rise in yields, whereas towards the end of an easing cycle, initial drops in rates have a relatively muted effect on yields, evidenced by instances where yields surged 50 basis points over a few monthsThis bleak view aligns with Citi's stance on maintaining a lower allocation towards U.Sinterest rates in their global asset strategy.
Furthermore, Citi's research points out that the termination of rate cuts is generally more beneficial for the U.S
dollar than simply pausingIn scenarios where easing is at a conclusion, the dollar tends to remain robust, while during mere pauses, it often displays volatilityGenerally, a pause leads to the U.Sdollar index engaging in range trading, whereas confirmation of easing's end could herald a more substantial appreciation in the dollar.
Notably, the findings point to a bullish sentiment on gold prices, as these typically move upward irrespective of whether the easing cycle persistsHistorical trends depict gold maintaining an upward trajectory, even when nearing the end of an easing cycle, validating Citi's bullish perspective on gold driven by central bank demand.
During pause periods, U.Sstocks often outperform European equities, albeit with considerable fluctuationsShould the easing cycle reach its conclusion, American stocks may experience notable retracements compared to the performance of the Euro Stoxx 50 index, though the general trend reflects horizontal volatility.
Citi also emphasizes that if the pause is confirmed as the end of the easing cycle, small-cap stocks are likely to outperform defensive stocks
Historical data indicates that in circumstances marking the conclusion of an easing cycle, small caps can significantly outperform utility stocksIn contrast, mere pauses tend to see small-cap stocks trading within a range relative to utilitiesThe overall analysis suggests a favorable bias toward small-cap stocks over defensive equities.
In emerging markets, Citi reinforces the expectation for strong performance in arbitrage opportunities, especially if the situation is framed as simply a pause in the cycleIf the Fed's actions are perceived merely as a pause, emerging market arbitrage is likely to continue benefiting from the trade environmentIf, instead, the easing cycle is concluded, emerging market arbitrage could initially suffer significant downturns, though it would ultimately recoverOverall, the dynamics of pauses or the conclusion of the cycle do not undermine the viability of long/short arbitrage trades.
In conclusion, the implications of the Fed's recent hawkish signals are multifaceted, presenting both opportunities and risks across different asset classes