Why a Fed Ease Might Not Mean What You Think

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The most talked- and written-about event in recent memory is the upcoming FOMC meeting. On Tuesday, the Federal Reserve will announce whether they plan on making a change to their short-term interest rate target.

I am neither an economist nor Fed theorist, so I will not bore you with my take on what they should do. Based on historical movements between current short-term market rates and Fed target rates, it's clear that we should expect a cut on Tuesday, but we have a new Fed Chairman and I have no idea what he actually will (or won't) do.

Instead, I want to take a look at historical cuts in rates, as that may provide a useful primer on what we could expect to see going forward. Even more important, I want to counter some prevailing wisdom that I've read and heard.

There seems to be no question that when the Fed cuts rates, stocks will rise, the U.S. Dollar will fall and gold will rise. There is so much consensus on that opinion that it seems a foregone conclusion.

The idea that stocks will rise I can understand - that argument has solid historical precedent as we will see. But the other two I don't get, as it flies in the face of history. Surely, the current situation is different from others over the past 30 years, but it isn't just interest rate differentials that drive currency movements, and we should go into next week with a clear view of history.

Below, I show each of the eight instances since 1971 when the Fed lowered the discount rate after a period of raising them, or going more than a year with no changes.

I used the discount rate as opposed to the federal funds rate because until recently, the discount rate was a primary tool of the Fed, and their historical data is much more precise than it is with the federal funds rate.

Not only that, but the two rates have moved pretty much in lockstep and we don't lose much in translation. Also, the Fed already lowered the discount rate last month, so these historical precedents are currently in effect. In some instances, the Fed data is somewhat ambiguous, with no actual date given of the Fed action, so we had to make an educated guess as to the precise date of their change.

For each occurrence of the Fed easing, we'll see a chart of the Dow Jones Industrial Average, the US Dollar Index, Gold and the CRB Commodities Index.

The gray dotted vertical line highlights the date that the Fed eased the discount rate. The blue dotted lines show the general trend in each asset class from the date of the easing until one year later. Following each chart is a table that shows the return in each class one year later, along with the maximum gain and maximum loss each encountered during the year.

	1-Year Return	Max Gain	Max Loss
DJIA	+41.8%	+52.7%	N/A
US Dollar Index	+4.0%	+4.7%	-4.2%
Gold	-21.1%	+4.6%	-26.4%
CRB Index	-12.4%	N/A	-19.9%

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Market reactions after all eight discount rate cuts are reserved for subscribers

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