• Performance of key market assets resembles the 2006-07 period

• The S&P 500 index could experience a sizable correction

• The current US 10-year yield drop could have legs

• Yen could benefit further as euro/dollar volatility is possibly heading north

Almost one year after the last Fed rate hike, the latest developments in the US, predominantly the recent labour market report and last week's weaker inflation prints, have probably tipped the scale in favour of the much-expected Fed rate cut. The market is fully pricing in a 25bps rate move at the September meeting, despite last weekend’s gun attack on the US Presidential candidate Donald Trump complicating somewhat the Fed's outlook.

In a special report published earlier this year, the performance of key market assets during the three occasions since 2000 – in 2000-01, 2006-07 and 2018-19 respectively – when the Fed paused after a rate hiking cycle was analyzed. The key findings were that (1) the S&P 500 stock index experienced a strong rally in two of the three occasions examined, (2) the 10-year US treasury yield decreased significantly and (3) gold showed a tendency to go higher.

Two months before the key September Fed meeting and one month before the Jackson Hole symposium, which could seal the Fed rate cut, the current market performance bears great resemblance to the period ahead of the September 2007 Fed rate cut. Therefore, what could be in store for certain key assets?

Chart 1 below shows the price action of the S&P 500 index during the Fed pause intervals, and it is quite obvious that the current movement of the index closely follows its performance during the 2006-07 episode. Importantly, in the July-August 2007 period, when the market was preparing for the Fed rate move, early concerns about the health of the housing sector, which eventually led to the subprime mortgage crisis, pushed the S&P 500 index lower by around 10%. It managed to temporarily recover going into the September Fed meeting.

Therefore, if history repeats itself, then this key US stock market index could experience a correction ahead of the expected September rate cut. Such a correction this time around could push it towards the 5,100 area.

A combination of the ongoing dollar weakness and the alleged intervention by the BoJ to support the ailing yen has pushed the dollar/yen pair towards the 156-yen area. A similar intervention in late April produced a 5% correction but proved temporary as dollar/yen then gradually climbed to a new all-time high.

Compared to the performance of dollar/yen in the previous Fed pause periods, the move higher in 2024 has been extraordinary. However, similarly to the S&P 500 index, this currency pair has been recently trading in parallel with the 2006-07 interval. Interestingly, a strong downtrend started in July 2007 that pushed dollar/yen up to 8.5% lower ahead of the September 2007 Fed gathering. Considering the current correction, a similar move this time around could lead dollar/yen down to the 148-yen area, close to the midpoint of the 2024 price action.

While euro/dollar is probably the least predictable security among the ones examined in this report as history does not point to a specific pattern, euro/dollar 1-month implied volatility is more interesting. Current volatility has dropped aggressively after the recent risk events in the euro area, and it is almost identical to the 2006-07 period levels.

Unsurprisingly, a strong pickup in volatility was recorded in the lead up to the September 2007 Fed gathering and a similar move is probably expected to take place this time around as well. Apart from the Fed meeting, the global environment remains volatile especially due to the increased probability of Trump returning to the White House and both the Ukraine-Russia and the Israel-Hamas conflicts remaining unresolved.

The 10-year US Treasury yield has probably been accurately reflecting the indecisiveness of the Fed to make the first, and usually hardest, step in easing its current monetary policy stance. However, it appears to be finally moving as it is currently around 35bps lower from its early July peak of 4.50%.

Interestingly, back in the 2006-07 Fed pause interval, the 10-year US yield peaked around mid-June 2007 before dropping by around 80bps going into the September 2007 meeting. Considering the latest developments and the recent Fedspeak, US yields could follow an analogous trend going forward. A similarly sized drop from the recent local peak of 4.50% could push the 10-year US yield towards 3.70%, the lowest yield since July 2023.