Trader’s Narrative

Most people assume automatically that a sustained interest rate cut campaign by the Federal Reserve has obvious consequences for the stock market, the dollar, commodities and gold.

The common line of thinking goes that interest rate cuts will help the market, by making equities more attractive relative to bonds, hurt the dollar by making it less attractive in the currency market, push up inflation - in other words, boost the price of commodities, and naturally then, push up the price of gold.

Myth Busters
But is any of that actually true? Does the real market history bear similar witness or are these assumptions… nothing more than myth?

Jason Goepfert of Sundial Capital (SentimenTrader.com) looked at the 8 instances since 1971 where the Fed embarked on an interest rate cutting rampage. He then looked at what effect that had on the various markets.

What?
The results are surprising. Interest rate cuts are good for the stock market. But that’s where the easy thinking ends.

The US dollar, in contrast to all you’ve heard, actually was the better for such slashing of rates. Commodities and gold were the poorer for it. And the long side of the bond market was mixed.

These results are aggregate data, smoothing out each year, of course. And we could have an aberration to the general tendency and see the dollar tank further, gold go up and stocks go down. Anything can happen in the markets.

Here are the graphs for 2001 as an example of the 8 instances:

You can try out Jason’s fantastic service for 14 days at no charge. I suggest you take it for a free spin. If you’re serious about the market and want this kind of fresh, unbiased analysis.

Last time I wrote about the beleaguered US dollar, it was just kissing its long term support at 80.

It managed to bounce (feebily) making it the sixth time to bounce off that support line. Alas, it seems there won’t be a seventh as the US dollar has managed to fall through to close around 79.

Take a careful look at this chart of the US dollar index:

Notice anything? It isn’t the recent chart. It is from 1992. Notice how it resembles our more contemporary US dollar index? The rally at the beginning of the year and then the fall into the summer? the fall through long term support?

Catch Up
Something else we have in common with 1992 is that the short term T-Bill rate had started to fall rapidly - ahead of the Fed funds rate. Then, as now, the Fed found itself in the all too familiar game of catch up and repeatedly lowered rates to match the rates set in the freely traded fixed income market.

So what happened to the dollar? Did it crash through the floor and go to zero? Did all hell break loose? Surely with the dollar so weak and the Fed reducing rates like mad, the currency market must have taken the dollar behind the tool shed.

Well, not quite. Here’s what happened next:

Although the similarities are remarkable between now and then, there really is no reason for history to repeat. As Twain quipped, history rhymes, not repeats exactly.

My point is that right now everyone expects the dollar to crash as the Fed lowers rates. But things seldom occur the way everyone believes they should. Popular “logic” has a tendency to be ignored by the market.

And if you recall macroeconomics 101, interest rates are important but there are a few more variables that go into the valuation of currencies. I have no idea whether we’ll see the 1992 rally repeat, but frankly, it wouldn’t surprise me.

Here’s a recent weekly chart for comparison: