In a surprising twist, the Federal Reserve has indeed lowered interest rates by 50 basis points, marking a significant event in the monetary policy landscape of the United StatesThis decision has reverberated through financial markets and has sparked discussions about its implications for the economy and various asset classes.

Historically, cuts of this magnitude are rare; since the 1990s, the Fed only initiated such drops in 2001, 2007, and 2020, each during periods tied to economic recessionsThus, the current prevailing narrative that a recession is not imminent was challenged drastically following this latest decision.

Prior to the announcement, out of 114 economists surveyed, merely nine anticipated a cut of this scale, underlining the unexpected nature of the Fed's action

Following the decision, many pundits found themselves with egg on their faces, as the magnitude took many by surprise.

However, the initial optimism following the announcement in the stock and gold markets swiftly dissipated, largely due to dovish commentary from Fed Chairman Jerome PowellHis remarks tempered expectations further for future aggressive cuts, causing a decline across various markets.

The meeting raised pertinent questions not only about the immediate ramifications but also about the broader trajectory of economic recovery and the direction of financial markets following the initial cutAnalysts and investors alike are now looking to decipher both Powell's message and the Federal Reserve's broader policy intentions moving forward.

Initially, the market reaction was bullish

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Stocks and precious metals saw upward movement as optimism reignedBut the tide soon turned, as Powell's hawkish comments prompted a reevaluation of future interest rate pathways, creating a ripple effect throughout financial assets.

One fundamental reason for the subsequent decline in markets was that the reduction had essentially been priced inAnalysts observed that leading up to the announcement, futures markets indicated a 66% probability for a 50 basis point reduction, a clear indication that the markets had already responded to this potential cut.

Had the Fed opted for a lesser 25 basis point decrease, analysts predictively suggested it could have triggered a severe market downturn, as the reduced expectation would have run counter to prevailing market sentiments.

Furthermore, Powell's hawkish stance on future rate movements also spooked investors

He made it clear that this 50 basis point cut should not be interpreted as a signal for future cutsThe pace and timing of subsequent reductions would be contingent on economic conditions at each meeting.

By raising the long-term nominal equilibrium rate to 2.9%—up from an earlier estimate of 2.5% for the end of 2023—the Fed signaled a departure from the extraordinarily low rates that had characterized the pre-pandemic eraThis raised concerns over the permanence of these low interest rates.

The revised forward guidance suggested the Fed may implement two additional cuts this year, totaling 50 basis points, alongside another four cuts totaling 100 basis points in 2024. The overall anticipated easing cycle, including the latest adjustment, would amount to 250 basis points, with end rates projected to settle between 2.75%-3%.

Contrary to market expectations, the Fed's approach appears to lag behind anticipated future easing

While traders anticipated aggressive pivots towards lower rates, Powell’s commentary conveyed a more measured approach moving forward.

A more pressing consideration remains the point of termination in the interest rate cycle, raising critical questions about the Fed's inflation strategy moving forward.

While Powell acknowledged this cut serves as a corrective measure for missing opportunities in earlier meetings, it raised skepticism regarding the efficacy of Fed policy and whether true economic stimuli are in motion.

The notion that this cut was, in reality, compensation for an earlier decision, rather than a decisive shift in policy, left risk assets feeling underwhelmed

Analysts believed the Fed had not sufficiently alleviated fears regarding an approaching recessionIn contrast, safe-haven assets also faced pressure due to ongoing economic stability and inflationary concerns.

Looking ahead, various asset classes will likely respond differently as the economic landscape unfoldsIf the economy encounters a hard landing, the equity markets typically see a downturn following initial rate cuts; conversely, a soft landing could yield continued stock market growth.

Historically, instances of soft landings, such as in 1984, 1995, and 2019, saw robust performance in stock marketsAccording to Goldman Sachs, in scenarios where recessions were avoided, the S&P 500 frequently rose by 10-17% post initial cuts

However, in recession environments, declines of 15-20% were common.

Moreover, the pace of rate cuts can influence the volatility of major asset classesData from the last seventy years suggests that following periods of aggressive rate cuts, the S&P 500 experienced an average maximum drawdown of -20.7%. In comparison, slower easing cycles register a milder average maximum decline of only -7.4% over the same timeframe.

In terms of performance over the longer term, since 1973, the average return of the S&P 500 three months after an initial cut has been -1.1%; however, this shifts to a +4.4% return six months down the line, and a +4.9% return after one year.

Sector performance during these phases also exhibits variations based on whether an economy achieves soft landings or faces recession

In previous soft landing scenarios, sectors such as healthcare, information technology, and financials tended to outperform following initial cuts.

However, during recessionary conditions, sectors like materials emerged as rare beneficiaries post cuts as the short-term negative impacts from declining profits overshadowed the positive effects of monetary easing.

Regardless of whether the economic environment is recessionary or not, the past thirty-six years reveal that sectors such as consumer goods, technology, and healthcare typically thrive within the first year post a Fed cutConversely, sectors such as financials and energy generally lag behind.

In both outcomes, large-cap stocks usually exhibit slightly better performance than small-caps under smooth economic conditions, while the opposite holds true in recession scenarios.

As noted during the recessions of 2007 and 2001, the S&P 500 and the Russell 2000 displayed divergent performances post first rate cuts, underlining the complexities in market reactions.

In the bond market, ten-year U.S

Treasury yields typically experience a downward trend post cutsIn ‘soft landing’ scenarios, such as those experienced in 1995 and 2019, yields may stabilize and even rebound slightly as the economy maintains its composure.

Short-term rates are generally more reactive to policy changes and thus tend to decline quicker, contributing to a steeper yield curve than the extended-term bond yields.

The overarching market sentiment following this cut indicates cautious optimismHistorical trajectories show that after the first rate cut, future expectations for additional cuts frequently rise, enhancing liquidity conditions in the U.Sstock market.

This pattern occurred in four out of the past five easing cycles, suggesting that liquidity in the stock market may remain anchored.

Ultimately, whether the U.S