Market Alert: Can the Fed save the bull market?

Markets love monetary easing. There’s a broad consensus that a 11-year old bull market on Wall Street has been greatly supported by the Fed’s unorthodox measures. Many have started to believe that central banks can bail markets from any trouble. Now that the FOMC has just delivered an emergency 50 bps cut the question is urgent more than ever: can they?

Fed to the rescue

On the last trading day of February the Fed issued a laconic statement saying that the US economy was in a good shape and the Bank was monitoring the virus to see if there’s any impact. On Tuesday , it delivered an emergency, 50 basis point (a standard move is 25 basis points) cut. That’s a major change of heart over just few days, the Fed is suggesting that something could be serious and delivers a serious response. Normally, markets love easing. Last year when the Fed delivered 3 rate cuts and quasi QE on minor economic slowdown, it helped stock markets a lot. Little wonder, the first reaction to the Tuesday move was positive. But what if the emergency cut spells troubles ahead? Doesn’t such a quick change of narrative from the Fed suggest panic at the central bank?

What the history tells us

This is not the first time when the Fed delivers an emergency or outsized cut. Dot com burst, LTCM collapse, banking crisis - we saw these actions on many occasions. This allows us to track market responses to these actions. We selected 7 such responses over the past 50 years. There were more, but since some extraordinary moves occurred multiple times during a single crisis (for instances, 3 times during the global financial crisis), we only chose the first response because now it’s also the first time when the Fed makes such decision. What are the results? Quite strange indeed. The first month results in an average gain of 1% for the S&P500 (US500) as traders welcome the stimulus. The first 3 months have a negative return of 1.25% which means that the problem settled and the first reaction was more than reversed. However, the annual return from the cut is more than 5% on average suggesting that the action was successful after all.

Inconclusive: FOMC emergency cut on its own is not a recipe for a bull market. Source: Bloomberg, XTB Research  

Having said that, one needs to be very careful with such interpretation and study these cases separately. We can see that two big rallies that were also very consistent occurred in 1980 and 1998. The second case is very straightforward – the Fed cut was a response to the LTCM collapse and while there was no fundamental problem in the economy (not yet) the tech rally continued relentlessly. In 1980 where the fundamental situation was disastrous the rally occurred after a big slump from 1979 (not the case at present) and ahead of another tumble in 1981. The biggest culprit is 1974, the oil crisis, while the markets also went down in 2001 and 2007 but in these situations that was only a prelude to the real bear market.

Traders should watch the virus spread, not the FOMC

There’s one conclusion from the above – the FOMC cut does not stop the bear market if the underlying problem is really serious. Is it the case right now? We do not know it for sure yet. If US and Europe are forced to implement the Chinese style restrictions (that led to -80% car sales in February – just as an example) the case would be very serious. Which is why traders should track the virus spread data that we share everyday in the “Market Wrap”, the first research post on the xStation platform.

The virus spread has been rapid so far. Source: Worldometers, XTB Research

Watch out for gold

One thing that should be added is that the response of gold prices has been more consistent on average. A factor that should be noted now, when central banks seem to be losing their credibility.

Gold prices rose over 10% in 6 months following 7 past emergency rate cuts. Source:  Bloomberg, XTB Research