Will Another Fed Rate Cut Rescue U.S. Stocks?

All eyes will be on the Federal Reserve’s policy setting open market committee this week (FOMC) which begins a two-day meeting tomorrow in Washington. By about 2:15 pm  Wednesday, expect the FOMC to announce another cut in the benchmark Fed funds rate – most likely by 25 basis points this time around – as a follow-up move to the Fed’s surprise half-point cut in September.

Since the Fed’s last move financial market conditions have grown somewhat less stressful, with commercial paper rates easing from wide spreads over the Fed funds rate in August. However the news on housing continues to be dismal, with existing home sales plunging another 8% in September to new lows, as reported last week.

Typically, Fed interest rate cuts are good medicine for stock investors. In fact, since 1990 when the Fed has cut rates the S&P 500 has rallied 5.5% on average within the first four months after the Fed’s first easing. Stocks usually go on to post double-digit gains within one-year.

But not all Fed rate cuts are created equal. The last major campaign of easing rates from 2001 to 2003 was in the midst of growing stock market stress as a result of the tech-bubble bursting on Wall Street.

As the chart above shows, the Fed cut rates repeatedly during this period – from over 6% in 2000 all the way down to 1% in 2003 – but this failed to help the stock market enjoy a sustained rally.

In fact, the S&P 500 fell about 40% even while the Fed was continuously cutting rates, before stocks finally began moving higher in 2003 – more than two years after the Fed’s first rate cut in 2001!

This time around, Wall Street is suffering from stress brought on by the bursting of the housing bubble. So the big question is, will another Fed rate cut this week (with more likely to follow) help stocks recover or not?

Above is another interesting chart that shows the S&P 500 enjoyed a nice rally after the Fed’s first rate cut in September, only to roll over again in recent weeks.

In fact, the S&P 500 is now trading below the level it was before the Fed’s surprise half-point move. Stay tuned!