What to Buy During Fed Rate Cuts in a Recession?

We know that rate cuts can come in two forms: preventative and recession-driven. Preventative rate cuts occur when the economy is slowing down, aiming to stimulate business expansion and consumer spending, usually leading to higher asset prices. In contrast, recession-driven rate cuts happen during an economic crisis to salvage the economy, often resulting in significant drops in asset prices.

So, what should you buy during a recession when rate cuts are in play?

Rate cuts will lower interest rates on bank deposits and bond yields. As bond yields decrease, bond prices generally rise, regardless of the overall economic situation. Therefore, during a recession, you should buy U.S. Treasury bonds.

Looking at recent recessions: In July 2024, concerns about a recession caused by employment data and CPI led to a sharp drop in the Nasdaq, but U.S. Treasury bonds (TLT) rose. In March 2020, recession fears from the COVID-19 outbreak led to a quick drop in the Nasdaq, while bonds increased. Similarly, during the subprime mortgage crisis from August to December 2008, the Nasdaq fell sharply, but bond prices went up.

In summary, when recession concerns arise, sell stocks and buy bonds. Once the recession fears ease or the recession ends, sell bonds and buy stocks. This approach is more effective than doing nothing, as you can’t predict the duration of a recession—what if it lasts as long as Japan’s 30-year stagnation?