Which investment strategy should one adopt in light of a potential Fed rate decrease?

A week strongly marked by a dovish atmosphere is behind us and most of the world's largest Central Banks are now moving towards relaxation due to downside risks to growth.

The last Federal Reserve meeting showed that eight of the 17 participants in the Federal Open Market Committee (FOMC) had forecasted rate cuts this year, while the interest rate market went even further, with just over two 25-basis point reductions in 2019. Some analysts, such as UBS Chief Economist Seth Carpentier, are even calling for a 50-basis point reduction next month.

Subsequently, the debate continues regarding the possible duration of this easing cycle.

There are certainly parallels between today's environment and that of 1995-1996. At the time, the Fed embarked on a threefold series of interest rate cuts (75 basis points in total), the catalyst being low inflation rather than an economy in recession, which is truly similar to today's situation. The entire cycle lasted seven months.

One of the upcoming questions for investors is therefore how to invest through this likely series of future interest rate cuts in light of weakening economic activity.

According to recent weekly data from Merrill Lynch, capital inflows into U.S. equities have accelerated to about $16.7 billion, their highest level since March, coinciding with the S&P and the Dow both reaching new historical highs.

While fixed income securities also posted strong gains as an asset class - with 10-year U.S. bond yields falling below 2% for the first time since November 2016 - inflows into government bonds and high quality securities rose to $4 billion from $9.8 billion a week earlier.

David Kostin, an analyst at Goldman Sachs, analysed stock market returns over the past 35 years following the start of the Fed's downward cycles.

His analysis shows that the S&P Index rose by a median of 2% and 14% over the three and twelve month periods following the start of a cycle. The performance was strongest in the 12 months following the rate cuts of July 1995 and September 1998 (+23% in both cases).

In terms of sectors, the health and consumer staples sectors posted the best results, while technology shares posted the worst returns (-13% over 12 months).

For interest rate traders, the size of the reduction cycle will determine where the best investments will be located. Given that the forecasts are already for two rate cuts before the end of the year, it would be necessary to expect three or more over the next six months to observe a significant impact on the markets.