How do markets usually perform after rate cuts?

Last week’s cut to the Official Cash Rate (OCR) received a lot of attention, and rightly so.

It was the first since 2020 and it marked the end of 15 months at 5.50 per cent, the highest since 2008.

That sparked the biggest two-day rally in New Zealand shares for two years, and it’s helped the market rebound more than ten per cent from its recent lows.

Is the optimism justified, will it last and how have shares and bonds performed in the past following interest rate cuts?

I looked back at all the times the OCR has reached a peak in the last 25 years, and what happened after that first cut.

There have been five easing cycles since the turn of the century – starting in 2001, 2003, 2008, 2011 and 2015.

I haven’t forgotten about the COVID-era, but at that point an easing cycle was already underway.

The OCR peaked at 3.50 per cent in 2014 and 2015, and it had fallen steadily to one per cent by the time lockdowns ensured a recession in 2020.

Interest rates obviously fell further from then on, but it wasn’t the beginning of a decline from a recent peak.

Anyway, in the six months following the first OCR cut in those five examples, sharemarket returns were mixed.

Things become clearer if you look beyond that initial dust-settling period, and over 12 months the market was up on four out of five occasions, with an average return of 12.2 per cent.

In the 24 months following an OCR cut, the market was also up four of out five times, and the average return was almost 25 per cent.

Those returns are healthy and a hit rate of 80 per cent hit is solid, with the exception being the easing cycle that stated in July 2008.

That was during the GFC, when the economy was already in recession and any rate cut optimism was drowned out by an extremely difficult period for businesses and households.

It’s not dissimilar when looking at the history of easing cycles in the US.

Since 1980, there have been ten times when the Federal Reserve has started cutting rates from a peak.

The S&P 500 was up seven out of ten times in the next 12 months, for an average gain of 7.8 per cent, and eight times in the two years afterwards, for an average return of 24.1 per cent.

The only easing cycles that weren’t accompanied by positive returns were the ones that started in 1981, 2001 and 2007.

As was the case in New Zealand, those three examples were all around the time of recessions.

The case is clearer for bonds and fixed income.

In every easing cycle since the OCR came into being in 1999, the NZX Government Bond Index has delivered positive returns in the six, 12 and 24 months following that first cut.

That shouldn’t come as a surprise. Bonds and fixed income do well when interest rates are falling, even if there’s a recession.

In fact, the one easing cycle which saw local shares perform poorly (during the GFC) was the strongest period for bonds.

Investors benefit from the stable and predictable income they receive, while they can also see capital growth as existing vintages of bonds (issued when interest rates were higher) are repriced higher.

Now that the easing cycle is underway, last week’s OCR cut will be the first of many as we head toward the neutral level of three per cent, give or take.

We’re likely to see the US Federal Reserve’s first downward move next month too, with markets so the view that a quarter-point cut in September as a done deal.

This should make for a much more attractive backdrop for investors, with most assets typically performing well in the wake of rate cuts.

Nothing is a sure thing when it comes to investing, although history would suggest bonds and fixed income are very well-positioned over the next year or two.

When it comes to shares (and the same goes for property), the odds are good as well.

However, whether we see the usual strong gains that follow rate cuts might hinge on how economic growth develops from here.

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