How have major assets historically performed around the "first rate cut day" of the Federal Reserve?

Historically, U.S. stocks and bonds tend to rise around the time of the Federal Reserve's first interest rate cut, the U.S. dollar usually weakens before the cut, while gold performs strongly before the implementation of easing policies. This is the view of Citigroup's latest report, which provides a trading roadmap for the anticipated new round of interest rate cuts.

According to news from the Wind Trading Desk, as market expectations for the Federal Reserve to begin cutting rates this Wednesday heat up, Citigroup's Alex Saunders team predicted in a research report on the 16th that, based on downward pressure from employment risks, the Federal Reserve will announce a 25 basis point rate cut and signal further easing. This expectation forms the baseline scenario for current market pricing.

However, history does not simply repeat itself. Strategists in the report believe that during the interest rate cut cycle in 2024, the performance of most assets aligns with historical patterns, but bonds are a significant exception—its prices peaked at the first rate cut. However, this time is different, as current market pricing for the extent of rate cuts is far less aggressive than in 2024, reducing the risk of a sharp drop in bond prices.

Additionally, Citigroup believes that in the context of a sustained capital expenditure boom driven by artificial intelligence, policy easing is expected to support an economic "soft landing," which is favorable for the stock market. The report emphasizes that the current market environment is quite consistent with historical shallow rate cut cycles and soft landing scenarios, which may provide more lasting support for bonds in this cycle.

Historical Pattern: Stocks and Bonds Rise, Dollar and Gold Strong Then Flat

According to Citigroup research, historical data shows that the median performance of stocks and bonds around the first rate cut is positive. Stocks typically see a median increase of about 5% in the 50 days following a rate cut, but there are downside risks in a hard landing scenario. Bonds also benefit from expectations of rate cuts and actual cuts, with yields usually reaching a low point around the first rate cut.

The performance of the U.S. dollar index shows a "weak then flat" characteristic, typically weakening before a rate cut but entering a range-bound fluctuation afterward. Precious metals like gold also rise before the implementation of easing policies, but their performance tends to flatten after the actual rate cut, often showing a range trading pattern.

Citigroup analysts state that these historical patterns were largely validated in 2024, but bond prices peaked around the first rate cut. At that time, market pricing for rate cuts was quite aggressive, while the pricing in this cycle is relatively moderate, thus alleviating concerns about the bond outlook.

Reviewing 2024: Why Did Bonds Underperform Expectations?

The interest rate cut cycle in 2024 provided valuable references for investors, especially regarding the performance of the bond market. According to the report, the market in 2024 also anticipated a "soft landing," but the difference was that the rate cut pricing at that time was "extremely aggressive."

The report indicates that the market priced in a rate cut of up to 225 basis points in 2024, far exceeding the actual three cuts that occurred. This excessive pricing led to bond prices peaking and falling at the first rate cut. In contrast, the current market pricing for rate cuts is only 120 basis points, appearing more cautious. Citigroup believes that due to the less aggressive pricing, the risk of the bond market repeating last year's performance is lower. **

The trend of the US dollar in 2024 is also worth paying attention to. Although it weakened as expected before the interest rate cuts, after the cuts, driven by factors such as the US elections, its rebound exceeded historical typical patterns. Citigroup expects this scenario will not repeat. In addition, the current low level of the 1-year forward rate relative to the macro environment reflects the Federal Reserve's reallocation of risks and dovish pricing. This policy bias may further decouple from macro fundamentals, potentially providing more meaningful support for the stock market and driving economic re-inflation.

How deep will the rate cut cycle be? US stocks and inflation are key indicators

For investors, the depth of this rate cut cycle is crucial. The report analyzes that two major factors will determine the Federal Reserve's easing space: stock market levels and inflation trends.

Historical data shows that when a rate cut cycle begins, if the S&P 500 index is at a high level (as it is currently), subsequent rate cut cycles tend to be "shallower." On the other hand, if the overall Consumer Price Index (CPI) shows a significant decline before the rate cuts, it indicates that the Federal Reserve is more likely to implement aggressive easing.

The year 2024 is an exception in this regard. Although inflation was significantly declining at that time, due to its high starting point, the eventual rate cut cycle remained shallow. Citigroup believes that the current market performance aligns with a shallow rate cut cycle and a soft landing scenario.

Intraday: "Knee-jerk reaction" after decision announcement and final trend

In addition to cyclical patterns, the report also delves into the intraday trading patterns on the day of the Federal Open Market Committee (FOMC) decision, providing tactical references for short-term traders.

• Stock Market: Typically experiences a "knee-jerk" rise after the FOMC statement is released, especially before the press conference begins. However, this upward trend often gets fully reversed before the market closes. The report points out that the negative price reaction in the first 5 minutes after the decision announcement tends to have stronger persistence, while positive reactions are more likely to reverse.
• Bond Market: In contrast to the stock market, bond prices often "hold steady" after rising following the decision announcement, while sell-offs tend to reverse. After a dovish FOMC meeting day, the bond market still has some upward momentum in the following 10 trading days.
• Foreign Exchange: For currency pairs like EUR/USD, the FOMC's "hawkish" surprises (marked by a significant rise in 2-year US Treasury yields) have the most lasting impact. The report shows that after a hawkish FOMC meeting day, the strength of the US dollar can persist for up to 20 trading days, leading to a decline in EUR/USD of more than 1%