U.S. Federal Reserve rate cut takes us back to 1998

           

The U.S. Federal Reserve reduced its benchmark interest rate by 0.25% on Wednesday afternoon, a move that was widely anticipated based on the potential for weaker global growth and ongoing trade uncertainty. At this time, we do not believe the Fed's decision is in response to a looming recession—instead, we see it as a form of insurance against the risks mentioned earlier. Just last month, Chairman Jerome Powell remarked “based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook."

Rate hike to rate cut isn't common practice

The last time the Fed did so was nearly 20 years ago, in 1998, following the “Asian Crisis," where the collapse of the Thai Baht caused currencies and asset prices to fall precipitously across several South Asian economies. Fears of global market contagion pushed the Fed to cut rates just seven months after raising them. In fact, the Fed cut rates three separate times on that occasion, 0.25% each time. For the most part, the cuts worked—the next recession didn't start until March 2001, nearly three years later.

No further rate hikes in sight

So what about now? The move to cut rates means we are likely a few years away from seeing another increase, especially given the Fed inflation target of 2%, a challenge when global inflation is lacking due to structural factors (globalization, technology and energy prices to name a few).

Low inflation and geopolitical uncertainty would typically support the case for holding rates steady, however the target rate is much closer to zero than it has been in the past, likely pushing for this proactive approach from policymakers. Essentially, a preemptive rate cut now can help minimize the likelihood of needing to go even lower later (given that rates are near the zero bound, any increase in flexibility will be appreciated).

Yield curve misconceptions

It should also be noted that U.S. yield curve inversion fears are largely unfounded and not a sign of a looming recession at this time. The state of the curve today reflects extremely low term premiums (the difference between short-term bond yields and longer term bond yields) resulting from a weaker global economic outlook and not so much U.S. weakness. Extremely low rates in many other countries are generating more demand for shorter term U.S. treasuries.

We remain well-positioned

Given that this decision was widely expected (and was our base case), we remain well positioned for the current market environment. As always, we will continue to monitor the situation closely for any new opportunities or risk as they arise.

 

About the Author

Patrick Ercolano

Patrick Ercolano, CFA, MBA, is a former Lead Portfolio Manager with the Investment Management and Strategy team at MD Financial Management. He oversaw the strategic and tactical asset allocation mandates, alternative investment mutual funds and was a member of MD’s Tactical and Risk Allocation Committee.

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