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Fisher Investments Canada knows that, while investors have long preoccupied themselves with central bank policy, high inflation in recent years has led many to obsess over every word, tone change and data point that may cause policy to shift. As inflation has fallen back toward historically “normal” levels, some investors are calling for central banks, such as the U.S. Federal Reserve (Fed), to reverse the rate hikes of the past several years, which is something they see as necessary for the bull market to continue. But does this view align with history? And does the bull market – now more than one and a half years old – require rate cuts to continue?
We believe investors tend to overrate the influence of central banks on equity markets. In Fisher Investments Canada’s review, attributing the success or failure of the broader economy to one market driver – even one as widely followed as central bank policy – greatly oversimplifies the complexity of the global economy and equity markets. In this article, we examine how rate moves affect markets historically, the importance of understanding lending patterns and why forecasting rate moves is both challenging and unnecessary for long-term investors.
Are rate cuts, or hikes, inherently good or bad for equities?
If you’ve kept up with the financial news in recent years – ones Fisher Investments Canada reviews – there’s a good chance you’ve heard media pundits discuss central bank policy. Financial pundits clamber over one another to offer opinions as to what central banks should or shouldn’t do. Many investors believe rate hikes hurt equities, while rate cuts help – fearing that cuts are necessary to keep the current equity rally alive. However, history shows that changes in interest rates do not always have a predictable effect on equities (Exhibit 1).
Exhibit 1: U.S. Equity returns 12 months following rate hikes and cuts
Source: FactSet, as of 6/3/2024. S&P 500 Price Index Return and Initial rate cute dates of each interest rate cycle, 1/1/1950 – 29/2/2024.Supplied
In fact, since 1950, U.S. equity returns following rate hikes have been more consistently positive, with a higher average return than periods following rate cuts, which is a direct contradiction of the common media narrative. In fairness, it’s important to note a few arguable outliers following rate cuts somewhat skew the data. Notably, the past three rate cut cycles were followed by the bursting of a tech bubble, the Great Financial Crisis in 2008-2009 and the economic fallout from COVID-19-induced lockdowns – all largely atypical periods with material external factors beyond rate policy.
Regardless, the notion that rate hikes or cuts are inherently positive or negative seems exaggerated. Historically, markets have been positive more frequently than negative. And rate moves don’t seem to change that, one way or the other. In Fisher Investments Canada’s review, investors likely need to look beyond just rate policy to assess the potential market impact.
What do central bank rate changes actually do? Fisher Investments Canada answers
While we think the intense focus on central banks is unnecessary, policy changes can, and do, affect parts of our economy. Central bankers admit their tools are imprecise – sometimes referred to as “blunt instruments” – but ultimately believe rate policy is the primary way of slowing economic growth or boosting it. But as we’ve mentioned, the economy isn’t that simple.
If rate hikes were meant to constrain economic growth, as many believe, then why has the economy been relatively robust in the past couple of years? In Fisher Investments Canada’s review, it comes down to lending. Lending is the gas that fuels the global economic engine. And if rate hikes were meant to stymie lending, they haven’t been very effective. As Exhibit 2 shows, lending has remained resilient, only softening in recent quarters as weakness in Europe has dragged down global averages.
Exhibit 2: Global lending remains resilient, although pockets of weakness exist
Source: FactSet, as of 6/3/2024. Y/y GDP-weighted global loan growth, monthly, 31/12/2017 – 30/9/2023. Y/y Eurozone loan growth, monthly, 31/12/2017 – 30/11/2023. Y/y U.S., U.K. Eurozone loan growth, monthly, 31/12/2017 – 31/12/2023.Supplied
Central bankers – and by extension many investors – believe that hiking short-term rates helps lower loan demand and disincentivizes banks from lending. However, Fisher Investments Canada’s review of research shows that bank deposit costs have largely disconnected from short-term interest rates in recent decades as depositors opted for savings accounts over money-market instruments. So, while short-term interest rates rose quickly in the past couple of years, deposit costs only marginally increased. The results are low deposit costs for banks and a better return on loans from higher long-term interest rates, providing plenty of incentive for banks to keep lending.
Of course, central banks have more tools in their arsenal than just rate policy. The balance sheets of major central banks globally have ballooned in recent decades, particularly following the large stimulus programs in most economies following COVID-19-induced lockdowns. Some have taken small steps to unwind their balance sheet, but in a measured way. Additionally, central banks have stopped short of more restrictive bank regulation that could potentially crater lending. These policies are worth monitoring for risks, but seem unlikely to meaningfully change in the near future, in Fisher Investments Canada’s view.
Forecasting central bank policy – trying to predict the unpredictable
Even if rates had the effect many believe, central bankers are notoriously unpredictable, making it hard to accurately predict forthcoming rate policy changes. A notable recent example was when, prior to the June 2022 Fed rate meeting, Fed chairman Jerome Powell signalled 75 bps – or 0.75 per cent – rate hikes were not on the table.1 However, the Federal Reserve raised its benchmark rate 75 bps at the very next meeting and repeated it in the three meetings that followed. Unfortunately, as Fisher Investments Canada notes, this kind of quick reversal in central bank decision-making isn’t uncommon. The Fed’s own rate forecasts change frequently and seldom align with actual future policy rates (Exhibit 3).
Exhibit 3: Fed funds rate forecasts rarely align with reality
Source: FactSet and FederalReserve.gov, as of 28/12/2023. Data sourced from annual December Federal Open Markets Committee (FOMC) federal funds rates median projections. Effective Federal Funds Rate (EFFR) from 31/12/2013 – 27/12/2023.Supplied
It’s important to remember that central banks are often reactive, not pro-active. Conversely, equities price what’s likely to happen over the next three to 30 months. In most instances, central banks don’t have access to information unavailable to the general public. That’s why Fisher Investments Canada believes it’s important to conduct your own analysis and consider rate policy as just one of many factors that affect the global economy.
Rate moves or not, this bull market should continue in 2024
Fisher Investments Canada believes rate cuts aren’t necessary for this bull market to continue. As we have demonstrated, rate cuts don’t have a predictable influence on equities. Lending – a primary target of rate hikes – has seemed to operate independently of central bank policy. Equity markets have navigated the rate environment well and the economy has been more resilient than many people expected. In Fisher Investments Canada’s review, fretting over unpredictable rate moves is a fruitless exercise and, like potential rate cuts themselves, isn’t necessary at this time.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
Fisher Investments Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.
1 Source: "Why Powell took 75-basis-point rate hike off the table, and other takeaways from the Fed press conference", May 4, 2022
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