Executive summary
This report examines seven instances of Federal Reserve interest rate cut cycles since 1980 to identify patterns experienced by Government bond yields.
Key findings include:
- Short term and longer term Government bond yields tend to move 1% lower prior to the Fed first rate cut.
- Government bond yields tend to continue to move lower (on average 0.50%) following the Fed first rate cut (with limited moves higher in instances when that happens).
- Overall this gives credence to the “don’t fight the Fed” mantra (i.e not betting on yields increasing when the Fed cut rates).
- However the move lower in yields following the Fed first rate cut is inversely correlated to the amount the curve is inverted (i.e deeper inversion tends to cap the move lower in yields).
Introduction
Following the Federal Reserve's aggressive rate cut of 0.50% on September 18, 2024, bringing the benchmark interest rate to 5%, we delve into the historical performance of US Government bonds during similar monetary easing cycles. By examining seven previous instances of interest rate cut cycles, we aim to identify recurring patterns and potential implications for investors.
In this specific piece, we focus exclusively on US Government bonds to provide a more in-depth understanding of their historical response to such policy changes. For a broader impact of Fed rate cuts on various financial assets and economic indicators we recommend reviewing our earlier research: A (Short) Macro Guide To The Federal Reserve Interest Rate Cut Cycles).
Overall our analysis suggests that the adage "don't fight the Fed" often holds true during interest rate cut cycles. This implies that investors who bet against the Fed's easing policies may face an uphill battle..
Fed Fund Rate
We start this analysis by looking at the Fed fund rate itself. Based on previous rate cut cycles we can see that typically the median Fed fund rate tends to decline by 1.25% after 180 days following the Fed first rate cut.
Using this cycle starting interest level of 5.50% that would imply that interest would decline by another 0.75% to 4.25%. Based on Fed projections the current cycle might be deeper than the previous average cycle as the Fed already expects interest rate to finish this year at 4.50% and be at 3.50% by the end of 2025.
We can also see that over the last 20 years there have been interest rate cut cycles which have been deeper than 1.25% cut within 6 months, namely 2007, 2001 and 1984. Interestingly 2 were associated with recession (2001 and 2007) while 1984 wasn't (though the starting interest rate was 9.00%).
US Treasury Bills (T-Bill)
Having looked at the Fed fund rate we now move to the short end of the yield curve by reviewing the evolution of the 6-month and 12-month Treasury bill yield.
6-Month Treasury: As the chart below shows, the 6-month Treasury bill following the start of a rate cut cycle never really moved above the level it was when the first rate cut happened. This means for this cycle we should expect the 6-month T-Bill to not move significantly above 4.40%. Furthermore the median 6 month T-Bill yield tends to decline by 0.75% following the rate cut which would mean a 6 month T-Bill yield of 3.65% by March next year and in some cases the decline was much sharper.
12-Month Treasury: When we look at the 12-month T-Bill similar conclusion applies than the 6-month T-Bill . More specifically we see the 12-month T-Bill yield declining on average by 1% (so more than than the 6 month T-Bill). In the previous rate cycle we also did not see the 12-month T-Bill yield increase much post Fed rate cut (at most it increased by 25bps).
Curve Inversion: One final stylized fact to look at is the level of inversion of the curve (ie the spread between the 6-month and 12-month T-Bill compared to the Fed Fund rate) when the first rate cut happens. For the 6m and 12-month TBill it tends to be at 1% inversion (i.e. 6-month and 12-month T-Bill 1% below the Fed fund rate). While the current inversion of the 6-month T-Bill yield is somewhat in line with the prior rate cut cycle, the 1.50% inversion of the 12-month TBill is more negative than the previous instances.
Table: T-Bill Curve inversion when the Fed starts cutting rates
US Treasury Bills (T-Bill)
As we looked at the short end of the curve we can now look at longer dated Government bonds yields. Broadly speaking the main conclusion from the front end of the curve seems to apply (which is further indication that in a rate cutting cycle the front end tends to “lead” the move in the back end of the curve): i.e. typically longer term interest rate don't move much above their level seen when the Fed started cutting rates.
We can also notice that if rates sell off (i.e move higher) they dont sell off more than 0.50%. This corroborates the adage of not fighting the Fed during an interest rate cut cycle. Furthermore we can also see that the move lower in yields we have seen before the Fed cut rate this September is also very similar to what has been experienced in the previous rate cut cycles.
The charts below display the dynamic of the 2-year, 5-year, 10-year and 30-year bond yield before and after the rate cut.
2-Year Treasury: As we can see the 2-year yield has a tendency to decline by 0.50% within 60 days of the Fed rate cut before stabilizing a bit and then resuming its decline toward 1% within 6 months of the first rate cut. While the 2-year yield can move higher it is unusual and typically it doesn't back up more than 0.50%.
5-Year Treasury: The 5-year yield tends to rally by 1% going into the first Fed rate cut meeting and then move further lower by another 0.50% within 2 months (and afterward tends to be range-bound). In some instances yield can move higher by 0.5%.
10-Year Treasury: The 10-year Treasury tends to move lower by 1% into the Fed first rate cut meeting which is similar to what we experienced this year. Following the first rate cut meeting, yields can be range bound (in some instances they move higher by less than 0.50%, while in some others they keep declining). 30 days after the Fed rate cut the 10-year yield tends to resume its decline toward 1% below where it was when the Fed first started cutting rates.
30-Year Treasury: As we can see from the chart below the 30-Year Treasury yield tends to decline by 0.5% into the Fed first rate cut which is very similar to what we have experienced this year. Post Fed meeting rates tend to be range bound for about 30 days and then resume their decline by more than 0.50%.
A note on curve inversion: We can also look at the spread between longer dated yield and Fed fund rate at the time when the Fed first cut rates.
Table: Spread between Treasury note yield and Fed Fund rate at the time of the first rate cate (negative means the curve is inverted as the Treasury note yield is below the Fed Fund rate)
While longer dated yield tend to decline following the Fed first rate cut the following move is also negatively correlated to the level of the curve inversion when the Fed start cutting rates, meaning that the lower the longer dated yield relative to the Fed fund rate at the time of the first cut the lesser longer dated yield tend move lower post the fed cut. This negative correlation is displayed in the table below (and more pronounced for longer dated bonds).
Table: Correlation between theTreasury note yield and Fed Fund spread and subsequent move in yield 180 days after the Fed first rate cut
Conclusion
Our analysis suggests that US Government bond yields typically decline into and following the Federal Reserve's initiation of rate cuts, aligning with the "don't fight the Fed" principle. While the initial yield decline following rate cuts is generally observed, the magnitude of this decline may be influenced by the shape of the yield curve. In particular, inverted yield curves, where longer-term yields are lower than shorter-term yields, can potentially limit the downward movement in bond prices.
About Treasure: Treasure is a leading financial technology company that provides advanced cash management and embedded investment services via its proprietary API. With the Treasure API, businesses can seamlessly embed a complete suite of managed investment and cash management offerings into their own platforms. Beyond its innovative API, Treasure also provides a sophisticated cash management platform to hundreds of businesses to turn their idle cash into secure revenue. Discover more at treasurefi.com and treasurefi.com/api.
Disclosure: Investing involves risk, including loss of principal. The information provided is for informational purposes only and should not be construed as investment, financial, legal, or tax advice. This material should not be considered an offer or recommendation to buy or sell a security, or a recommendation of any specific investment or strategy. You should consult your own financial, legal, and tax advisors before engaging in any transaction. While information and sources are believed to be accurate, Treasure does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information. For more information about Treasure, please visit treasurefi.com.
