Following the US Federal Reserve’s September rate cut, labor data
may have more impact on markets than further cuts. Andrew Sheets,
Head of Corporate Credit Research, explains why.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts on the
Market. I'm Andrew Sheets, head of Corporate Credit Research at
Morgan Stanley. Along with my colleagues bringing you a variety
of perspectives, today I'll discuss why what the Fed does next
might not matter all that much.
It’s Friday, October 4th, at 2 pm in London.
Over recent months the Federal Reserve has been at the center of
the global market debate. After keeping policy rates unchanged at
the end of July, a decision the markets initially cheered, a
string of weak data in early August drove concerns that Fed
policy was behind schedule. The Fed then responded with a
larger-than-expected half-percent interest rate cut in September.
And so, given these swings, a common question for investors is,
understandably: What will the Fed do next?
But what if the Fed’s next move doesn’t matter all that
much?
Monetary policy is both powerful and weak. Powerful, because
interest rates impact so many decisions across the economy, from
buying a home, to financing equipment, to acquiring a competitor.
And it’s also weak, because how interest rates impact these
decisions can have a long and variable lag. It can be six to
twelve months before the full impact of an interest rate cut is
felt in the economy. And so that half percentage point cut by the
Fed last month might not be fully felt in the US economy until
June of 2025.
That lag is one reason why the Fed’s next move may matter less.
The second reason is what we think the market is worried about.
We think a lot of the market’s volatility over the last two
months has been driven by concerns that the US economy,
particularly the labor market, is weakening right now.
If interest rates are too high and the labor market is weakening,
then cutting more rapidly in the coming months might not make a
difference. Because of that lag, the help from lower rates simply
wouldn’t arrive in time.
Meanwhile, there’s also a view that interest rates might need to
fall quite a long ways to have the sort of impact that would be
needed if the economy is really slowing down rapidly: by the
Fed’s own Summary of Economic Projections (SEP), the policy rate
that neither helps or hinders the economy could still be about 2
per cent lower than the current rate – even after that half a
percentage point cut in September. Interest rates are well above
what could be neutral.
In short, if the data weaken materially over the coming months,
more Fed cuts may not necessarily help in time. And if the data
remain solid, Fed policy will have lots of time to adjust. It’s
the data, not the Fed’s next action, that are most important at
the moment.
We also see support for this idea in history. It’s notable that
some of the most aggressive US interest rate-cutting
cycles – 2001, 2008, February of 2020 – overlapped with weak
equity and credit markets. And it was smaller rate cutting
cycles – in 1995-96, 1998 or 2019 – that overlapped with
much better markets. And that makes sense; if one assumes that
it’s the data rather than exactly how much the Fed is cutting
rates that matter most to the market.
All of this especially feels topical today. Today’s better than
expected report on the US jobs market should support the case
that Fed policy is on schedule, and larger adjustments aren’t
needed. It’s good news.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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