Fed Rate Cut Roulette When the Economy is Strong

Believe nothing that you hear and only half of what you see, because many times the other half is an illusion. -Ben Franklin

Is it time to start popping champagne bottles now that the Fed finally initiated a new Fed rate cut cycle or an ominous sign of a future economic crash? The short answer is the former statement but to proceed a bit more prudently and thoughtfully. Put some trust in the "house" and Fed Chair Powell to potentially achieve an elusive soft landing.

After an almost year of incorrect predictions on the direction of rate cuts, recessions and inflation by all the media experts last fall leading to an illusion of uncertainty, U.S. stocks had a remarkably strong first half of the year. The Fed finally cut rates by a half point last week, commencing what is expected to be a steady easing of monetary policy over the next year with a larger-than-usual reduction in borrowing costs that followed growing unease about the health of the job market.

Historically, the Federal Reserve has responded to economic crises with significant rate cuts. After the Dotcom crash in 2000-2001, the Fed slashed rates aggressively, from 6.5% to 1% by mid-2003. Similarly, during the Great Recession of 2008-2009, rates fell from 5.25% to near zero (0-0.25%) to mitigate the severe economic fallout. (see chart below) More recently, following the 2018 stock market downturn, the Fed reversed its tightening policy with three cuts just in 2019, reducing the rate by 75 basis points to cushion against a slowing economy right before the pandemic arrived to then cut again down to .05 by April 2020.

While the Fed recently emphasized taking a “cautious and data-driven approach” over the next year following the recent 50 basis point rate cut, bringing the Fed funds rate down to 4.75%-5%, the expectation of at least 8 cuts over the next year by prediction boards sounds a bit more aggressive like throwing water on a fire.

Soft Landing Not Free Fall 

Did you know economists have predicted nine out of the last five recessions? 

Many economists and students of the market may still have one last gasp of pessimistic air to cover, declaring that recessions typically begin after the Fed starts a new rate cut cycle. Still, correlation does not always indicate causation. The Fed controls the thermostat of the economy and decreases interest rates to help create more money flow into the economy from lending to investing. If you look back at history, many Fed rate cut cycles started after a recession had already started to help heal the economy. Today’s case of the Fed cutting rates before a recession is like administering a flu shot before flu season to help minimize getting sick.

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