{"id":2313934,"date":"2024-09-19T06:00:00","date_gmt":"2024-09-19T10:00:00","guid":{"rendered":"https:\/\/monetizemail.com\/magatoon\/?p=2313934"},"modified":"2024-09-19T09:29:24","modified_gmt":"2024-09-19T13:29:24","slug":"fed-rate-cuts-are-unlikely-to-goose-the-stock-market-or-prevent-a-recession","status":"publish","type":"post","link":"https:\/\/monetizemail.com\/magatoon\/2024\/09\/19\/fed-rate-cuts-are-unlikely-to-goose-the-stock-market-or-prevent-a-recession\/","title":{"rendered":"Fed Rate Cuts Are Unlikely to Goose the Stock Market or Prevent a Recession"},"content":{"rendered":"

For many months economists and market strategists have suggested that a pending Federal Reserve \u201cpivot\u201d from policy stasis to sustained rate cutting will boost equity prices or at least preclude them from declining. Lewis Krauskopf at Reuters<\/em> last July wrote<\/a> that \u201cRate Cut Prospects Could Bolster US Stocks as Investors Await Earnings, Elections.\u201d That same month, more than a third of respondents<\/a> to Bank of America\u2019s monthly Global Fund Manager Survey<\/a> agreed that \u201cmonetary policy is too restrictive, the most restrictive since November 2008,\u201d yet they also revealed that their investment portfolios remained \u201coverweight in equities and underweight in bonds\u201d (\u201cInvestors Remain Bullish Driven by the Expected Fed Rate Cuts,\u201d Funds Society<\/a><\/em>, July 19, 2024). At Morningstar<\/em> last month<\/a>, Gordon Gottsegen reported that \u201cRetail Investors are Bullish on Stocks Ahead of the Fed\u2019s Rate Cut Next Month.\u201d<\/p>\n

In fact, decades of investment history surrounding Fed policy pivots from rate stasis to rate cutting show that cutting has rarely been bullish for equities if the cuts came in the wake of yield curve<\/em> inversions<\/em> (which reliably forecast recessions<\/a>). This distinction is relevant today because there\u2019s strong and growing evidence that the next US recession has begun already<\/a> \u2013 or will begin soon \u2013 because the yield curve has been inverted since late 2022<\/a> and remains so<\/a>.\u00a0<\/p>\n

Many economists and strategists remain unsure about a pending US recession, having not forecasted it in the first place, or because generally they doubt that something\u2019s real until it already passes them by.\u00a0 Similarly tardy will be the National Bureau of Economic Research, but that\u2019s by design, because it assigns \u201cofficial\u201d dates to the start and finish of each recession, so before it makes its public pronouncements it wants to be sure about the final status of oft-revised economic data. Unfortunately, such \u201cback-casting\u201d (and even the New York Fed\u2019s \u201cnowcasting<\/a>\u201d) doesn\u2019t help those who need foresight<\/em> and time to adjust<\/em> ahead of the trouble.<\/p>\n

At the Fed\u2019s Jackson Hole conference last month<\/a> officials signaled a series of rate cuts to begin soon at FOMC meetings. It would be the first rate cutting since March 2020. Figure One plots the Fed funds rate versus the 10-year T-Bond yield over the past six years and includes a year-ahead forecast of the Fed rate derived from futures contracts. The projection is for cuts leading to a rate of 2.75 percent a year from now. Today\u2019s rate is 5.25 percent, so moves to 2.75 percent would equal total cuts of 250 basis points.\u00a0 Bond yields typically decline amid rate cutting, so the yield curve might remain inverted<\/em> at least through next March.<\/p>\n

\"\"<\/a><\/figure>\n

If this is the Fed\u2019s coming move \u2013 cutting its policy rate substantially and quickly \u2013 it suggests a panicky policy; it betrays both a fearfulness and an eagerness to fight a recession which the Fed itself helped instigate by its previous, excessive, curve-inverting rate hikes.<\/p>\n

Rate cutting typically recognizes the problem (recession) after the fact but doesn\u2019t prevent the problem. Nor does rate cutting necessarily boost equities. It\u2019s true that lower interest rates (long and short) tend to be bullish for equities \u201call else equal\u201d (a lower discount factor applied to corporate earnings), but \u201call else\u201d is not<\/em> equal now; a recession means economic growth contracts and earnings decline, both of which undermine equity prices. Significant, rapid rate-cutting usually coincides not with an economic \u201csoft landing\u201d but incoming recession data. Rate cuts based on hindsight instead of foresight can confirm a recession but can\u2019t prevent it.<\/p>\n

Important relationships among Fed policy, the yield curve spread, recessions, and equity performance since 1968 are illustrated in Figure Two. All eight recessions have been reliably preceded (roughly 12-18 months in advance) by Fed rate hiking<\/em> that caused an inverted yield curve (depicted here as a negative yield curve spread, when short term interest rates lie above<\/em> long-term bond yields). In all these years, we find no case of a recession occurring after no<\/em> prior curve inversion and no case of a recession failing<\/em> to occur despite<\/em> a prior inversion.<\/p>\n

I count eleven episodes of persistent and material Fed rate cutting since 1968 (Figure Two). Eight cases came on the heels of curve inversion and three occurred after no<\/em> prior inversion. Only in the three other cases did Fed rate cutting not<\/em> coincide with recession and plunging equity prices. The three cases are 1971-72, 1984-86, and 1995-98. They\u2019re worth summarizing.<\/p>\n