Following the monthly jobs report on Friday, it is almost certain that rate cuts from the Federal Reserve will begin at the September 18 meeting.
While job growth was lower than expected, the U.S. economy still created 142,000 payroll jobs in August, and the unemployment rate dropped to 4.2%.
With the recent improved trend of inflation readings, it would take an extraordinary upside shock to inflation to derail the upcoming monetary easing.
The Fed does not have an excellent track record in avoiding recessions with rate cuts.
78% of the time, the economy was either already in recession or ended up in recession after monetary easing began.
Despite all this, stocks have been higher one year after rate cuts commenced two-thirds of the time.
The median return on the S&P 500 in the year after Fed rate cuts begin is 10.8%, with the six-month median return at 9.1%.
Most of the time, 10-year U.S. Treasury yields fell over the three and six months after the initial Fed rate cut.
The Fed began cutting rates in July 1995, which followed some stagnation in U.S. industrial production and an increase in the unemployment rate.
Assuming that the inflation rate continues to moderate, monetary policy becomes even more stringent if the Fed makes no change to short-term interest rates.
It is highly likely that the Federal Reserve will start cutting rates at its meeting on September 18th, following the release of its monthly jobs report on Friday. Despite less job growth than anticipated, the U.S. S. Although the unemployment rate decreased to 4.2% in August, the economy still generated 142,000 payroll jobs. While futures are pricing in roughly a 30% chance of a rate cut of 50 (0 points50 percent) basis points, the job growth was sufficient to anticipate that the Fed would start with just 25 (0 points25 percent) basis points at the September meeting.
The last major obstacle to starting the easing cycle is Wednesday’s consumer inflation (CPI) reading. Although it is lower than the 2 point 9 percent year-over-year reading for July, the Cleveland Fed’s CPI estimate for the upcoming report is 2 point 6 percent, matching consensus estimates. A remarkable increase in inflation would be necessary to thwart the impending monetary easing given the recent improvement in inflation reading trends.
This analysis examines the lessons that could be applied to future stock and bond returns by looking back at the last nine Federal Reserve easing cycles, which started in 1974. The Fed’s record of averting recessions through rate reductions is not particularly impressive. Seventy-eight percent of the time, the economy was in a recession or entered one after monetary easing was implemented. The Federal Reserve defended itself by claiming that high inflation hampered their ability to cut interest rates during the 1970s and early 1980s. All the same, stocks have increased two thirds of the time in the year since rate cuts started.
The SandP 500 has a 10 point 8 percent median return in the year following the start of Fed rate cuts, and a 9 point 1 percent median return in the next six months. Three easing cycles (1981, 2001, and 2007) resulted in a double-digit loss on the one-year forward stock return. Remarkably, despite a recession, there were four easing cycles with positive double-digit one-year forward gains: 1974, 1980, 1989, and 2019.
For the most part, 10-year U.S. s. After the first Fed rate cut, Treasury yields decreased over the next three and six months. Although it may seem strange that yields increased a year after the first cut, one should take into account that U. S. In order to combat inflation, higher rates were required during the 1970s and early 1980s recessions, which usually last less than a year.
It might be useful to take a quick look at 1995 and what it might teach us about the current state of the economy, as that was the most recent period of Fed easing that avoided a recession. In July 1995, the Fed started reducing rates after a period of stagnation in the U.S. S. industrial output and a rise in the jobless rate. Whether or not lower rates helped, both of those scenarios turned out to be brief hiccups, and economic growth proceeded.
The enormous recovery after the economy was shut down during COVID complicates the current economic cycle. The industrial sector revived, and jobless rates dropped to historically low levels. Although unemployment has risen from its lows, it is still at a historically low level. Industrial production has fluctuated sideways since the middle of 2022.
The Fed’s extremely restrictive monetary policy is demonstrated by the real (after-inflation) Federal Funds rate. If the Fed doesn’t adjust short-term interest rates, monetary policy gets even stricter, presuming that the inflation rate stays moderate. A 50 basis point (or 0.5 percent) cut at the September meeting would be reasonable, according to the elevated real Fed Funds rate level, so it is still very much within the realm of possibility. The likelihood of averting a recession may be higher than history suggests because the Fed has the power to loosen its strict monetary policy, which appears to be its only means of supporting the economy.
The likelihood that the Federal Reserve can overcome its historical odds and create a soft landing for the economy is priced in by markets based on stock valuations and forward earnings estimates. This appears to be a reasonable assumption and should be taken as the base case outcome in light of recent data and the Fed’s success in 1995.
But this Goldilocks result is by no means guaranteed. Price decreases for stocks and other risky assets would probably result from a recession. Investing in cyclical and high-quality, less sensitive to the economy stocks should provide some protection in the event that earnings and the economy contract. History suggests that premium bonds should offer some protection during a recession since bond yields are now back to providing a respectable return over anticipated inflation.
