Fed Emergency Rate Cut Rumors Fade, History Points to Stable Course
Tuesday saw a return to normalcy in interest rate markets, following recent turbulence that even sparked speculation of an unscheduled, emergency rate cut before the Federal Reserve’s planned meeting on September 18. Though dovish voices like Chicago Fed President Austan Goolsbee hinted at open options during a CNBC interview on Monday, the probability of an emergency cut has significantly dwindled, dropping from 58% to 14% on Polymarkets.
Key Takeaways:
- Uncertainty Remains: While the initial fear of an emergency rate cut has subsided, market expectations are still fluid, with the CME Group’s FedWatch tool suggesting a 64% chance of a 50 basis point rate cut in September.
- The ‘Bad News is Good News’ Shift: A shift in market sentiment is evident, as previously, economic weakness was perceived as a positive sign for potential rate cuts. Now, however, "bad news is bad news," indicating a change in investor outlook.
- History’s Lessons: Analyzing historical data provides a critical lens for understanding emergency rate cuts. These drastic measures have typically been reserved for extreme economic or financial crises, like global pandemics, severe asset price corrections, systemic financial crises, or acts of war.
- Current Conditions Don’t Warrant an Emergency Cut: While equity markets have experienced some declines, the drop doesn’t mirror the magnitude of past crises that triggered emergency rate cuts. Consequently, most experts believe current conditions do not justify immediate action.
Will the Fed Make an Emergency Rate Cut? History Advises Against Betting on It
While speculation about emergency rate cuts continues, historical data indicates a high threshold for such action. Bank of America economist Michael Gapen highlights that these cuts are typically employed in dire circumstances.
The S&P 500 has historically witnessed substantial declines during periods of emergency rate cuts. For instance, the index dropped by approximately 30% during the 1987 crash, around 40% during the tech bubble burst, 33% during the COVID-19 pandemic, and 55% during the Global Financial Crisis.
Even after the 9/11 attacks, although the S&P 500 declined by only 15%, the economy had already been shedding jobs for eight consecutive months.
Gapen stresses that these precedents set a high bar for intermeeting rate cuts, a threshold not met by the current economic environment. He emphasizes, "History suggests the bar for intermeeting cuts is extremely high and that conditions on the ground today do not warrant such action. Could we get there? Sure…we cannot predict the future, and our view on the fundamental health of the economy and vibrancy of financial markets may be misplaced. But if the question is, ‘should the Fed consider an intermeeting cut now?’, we think history says, ‘no, not even close.’"
Market Volatility and the Fed’s Tightrope Walk
The Fed’s current tightrope walk is evident in the recent market volatility. Despite the fading specter of an emergency cut, market expectations and sentiment remain sensitive to economic data. The recent shift from "bad news is good news" to "bad news is bad news" reflects the delicate balance between slowing growth and inflation concerns.
As George Smith, portfolio strategist for LPL Financial, notes, "After an extended period of a ‘bad news is good news’ market, with participants believing data on a slowing economy would give the Federal Reserve clearance to cut interest rates, we appear to have abruptly moved to a ‘bad news is bad news’ environment."
The upcoming September meeting will likely hold significant weight as the Fed grapples with its policy path. While an emergency rate cut appears unlikely, the possibility of a 50 basis point reduction remains on the table. The Fed’s decision will hinge on a careful assessment of economic indicators and the potential for a sustained economic slowdown.
The Bottom Line: History and Data Shape Fed Action
The recent wave of speculation about an emergency rate cut underscores the market’s sensitivity to economic signals and the Fed’s potential response. However, historical analysis suggests that drastic measures are reserved for dire circumstances, a threshold not reached in the current economic landscape.
While the Fed faces a complex balancing act amidst economic uncertainties, historical precedents and current data will likely guide its decision-making process. Investors should remain attuned to economic data releases and Fed pronouncements for insights into the evolving interest-rate landscape.
