In July 2019, the Fed embarked on its first rate cutting cycle in a decade. Although growth was positive, the committee was concerned that signals coming from weaker manufacturing, softer inflation and an inverted yield curve meant recession risks were rising. Chair Powell described this is as”mid cycle adjustment” to ease conditions and protect economic expansion.
The chart above details Fed fund rates during the last six easing cycles. In 1995 and 1998, the Fed engaged in pre-emptive cuts to extend the expansion. Like 2019, the Treasury yield curve was flat to inverted and unemployment was low. The Fed cut rates 75 basis points over a matter of months, the paused until resuming a tightening regime. Financial conditions eased and the economy continued to expand.
We believe a similar outcome is likely, provided central banks remain vigilant and geopolitical tensions cool. Although there is the possibility that trade issues continue to sap business confidence, we expect that the US and China want to avoid the inevitable recession that an outright trade war would cause. We take comfort that softness in global manufacturing has happened before in this post-crisis expansion, but dovish pivots by central banks extended the cycle.
But the risk to that outlook is that policital events create a large enough shock to cause a recession. This is especially true when central banks are operating with little room to cut rates further. In past downturns, central banks slahsed rates by at least 500bps. Today, the fed funds rate stands at just 1.75%.
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