Rate Cut Ripple

Thoughts on the Market vor 2 Jahren

0:00

3:30

As markets adjust to global volatility, our Head of Corporate
Credit Research considers when the Fed might choose to cut
interest rates and how long the impacts may take to play out.

----- Transcript -----

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 the market’s expectation for much larger rate cuts from
the Federal Reserve, and how much that actually matters.

It's Friday, August 9th at 2pm in London.

Markets have been volatile of late. One of the drivers has been
rising concern that the Fed may have left interest rates too high
for too long, and now needs to more dramatically course-correct.
From July 1st through August 2nd, the market’s expectation
for where the Fed’s target interest rate will be in one year’s
time has fallen by more than 1 percent.

But…wait a second. We’re talking about interest rates here. Isn’t
a shift towards expecting lower interest rates, you know, a good
thing? And that seems especially relevant in the recent era,
where strong markets often overlapped with fairly low interest
rates.

Zoom out over a longer span of history, however, and that’s not
always the case.

Interest rates, especially the rates from the Federal Reserve,
are often a reflection of economic strength. And so high interest
rates often overlap with strong growth, while a weak economy
needs the support that lower rates provide. And so if interest
rates are falling based on concern that the economy is weakening,
which we think describes much of the last two weeks, it’s easier
to argue why credit or equity markets wouldn’t like that outcome
at all.

That’s especially true because of the so-called lag in monetary
policy. If the Fed lowered interest rates tomorrow, the full
impact of that cut may not be felt in the economy for 6 to 12
months. And so if people are worried that conditions are
weakening right now, they’re going to worry that the help from
lower rates won’t arrive in time.

The upshot is that for Credit, and I would say for other asset
classes as well, rate cuts have only tended to be helpful if
growth remained solid. Rate cuts and weaker growth were bad, and
that was more true the larger those rate cuts were. In 2001, 2008
and February of 2020, large rate cuts as the economy weakened led
to significant credit losses. Concern about what those lower
rates signalled outweighed the direct benefit that a lower rate
provided.

We think that dynamic remains in play today, with the market over
the last two weeks suggesting that a combination of weaker growth
and lower rates may be taken poorly, not taken well.

But there’s also some good news: Our economists think that the
market's views on growth, and interest rates, may both be a
little overstated. They think the US economy is still on track
for a soft-landing, and that last week’s jobs report wasn’t quite
as weak as it was made out to be.

Because of all that, they also don’t think that the Fed will
reduce interest rates as quickly as the market now expects. And
so, if that’s now right, we think a stronger economy and somewhat
higher rates is going to be a trade-off that credit is happy to
take.

Thanks for listening. If you enjoy the show, leave us a review
wherever you listen and share Thoughts on the Market with a
friend or colleague today.