A new rate regime calls for a closer look at your investment game plan

Interest rates and expectations about the next Federal Reserve decision are always important topics in our Portfolio Construction Solutions team’s discussion with financial advisors. In September 2024, the Fed cut the federal funds rate by 50 bps (one basis point is equal to 0.01%) after being on pause for more than a year, signaling a regime change. In this portfolio construction insight, we’ll take a look at how previous rate-cutting regimes impacted the performance of stocks, bonds, and cash. Our goal is to arm you with the information to make informed decisions for you and your clients.

T. Rowe Price’s Multi-Asset Division recently published research on interest rate-cutting cycles, identifying 12 such regimes since January 1954 (Figure 1). Cycle duration has ranged from five months to 40 months, with the average regime lasting 16 months. A standard deviation of 11 months, however, suggests that there is a good deal of variability in cycle duration. In simple terms, about half of the cycles lasted one year or less, and about half lasted longer than one year. Twenty five percent of the cycles lasted two years or more. Importantly, interest rates fell by between 75 bps and 1,050 bps during these cycles, and the average decrease was 453 bps.

We evaluated the performance of U.S. large‑cap stocks, bonds, and cash over prior cycles (Figure 1). But before we discuss this performance, please keep in mind that there are only 12 cycles, and some are very short, especially if split in half. While no data covering past performance can be reliable indicators of future results, we believe the analysis can be informative.

Figure 2 further breaks down the asset class performance in each cycle into three time periods: The first half of the cycle, second half of the cycle, and the full cycle. In general, the hit rate (the percentage of instances a stated result is achieved) of positive returns for U.S. large‑cap stocks looked good across the full cycle and in the second half of the cycle. Stocks moved from a 50% to 75% success rate from the first half to the second half of prior cycles.

Figure 3 suggests that U.S. large-cap stocks tended to underperform in the first half of a cutting cycle, with success ratios of 25% and 50% versus bonds and cash, respectively (success ratio refers to the percent of time that stocks outperformed other asset classes). In the second half of the cycle, however, stocks performed much better on a relative basis, with success ratios of 75% versus both bonds and cash. Over a full cycle, stocks had a 58% success ratio over bonds and 75% success ratio over cash.

In Figure 4, we looked at the average 12-month returns at different starting points: At the time of the first cut, three months after the first cut, and six months after the first cut. It’s clear that stocks tended to perform better on average the further removed they were from the first cut. Bonds performed best at the first rate cut and declined modestly in subsequent periods. Not surprisingly, cash declined the further in time we moved from the first rate cut.

Figure 5 shows the 12 month return of stocks, bonds, and cash following the first rate cut of the cycle. As shown, the three asset classes generally fared well over the 12 months following the initial rate cut, although there was a wide range of outcomes, particularly for stocks.

At the start of the current cycle, the Fed is lowering interest rates with the economy still in pretty good shape. This is in contrast to most prior cycles, which typically began with declining GDP growth. Moreover, stock valuations are high, likely reflecting a relatively favorable economic environment. And while past performance is not indicative of future returns, our analysis suggests that investors could consider reallocating their portfolios for the new rate-cutting regime.

If you’re seeking information on ways to position your portfolios for a new interest rate regime, we can help. Supported by the multi-asset experience and global resources of T. Rowe Price, our integrated suite of Portfolio Construction Solutions is designed to address your portfolio construction needs and help position your practice for success.