While central bank policy will always matter for markets, our
Head of Corporate Credit Research Andrew Sheets explains why
investors should not be worried about the number of Fed cuts in
2025.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of
Corporate Credit Research at Morgan Stanley. Today I’m going to
talk about why the number of Fed rate cuts this year may matter
less than you think.
It's Wednesday, March 5th, at 2pm in London.
Financial markets spend a lot of time discussing the Federal
Reserve. And for good reason. The central bank of the world’s
largest economy plays a central role in fighting inflation and
setting interest rates. And what they’ll do this year is topical
and shifting. At Morgan Stanley, our economists think that US
Tariff and Immigration policy will lead the Fed to keep rates
somewhat higher, for somewhat longer, than they did at the start
of the year.
Yet we think there may be just a little bit too much focus on
just how much the Fed changes policy over the course of the year.
Indeed, we’d go as far as to say that given the choice, investors
should be rooting for less change, not more.
To start, for all that’s happened in the world since the end of
October of 2024, expectations for the Fed’s interest rate path
have been remarkably stable. The US 2-year Treasury, which is a
decent proxy of where the Fed’s rate will average over the next
24 months, has hovered in a very narrow range. It simply hasn’t
been telling us very much; other factors have been moving
markets.
There’s also a pretty reasonable rule of thumb from history:
stability is good. A stable Fed funds rate, almost by definition,
implies a stable equilibrium that doesn’t involve overly high
inflation pushing rates further up, or overly weak growth pushing
them further down. The best growth in recent history, in the
mid-1990s, occurred after the Fed reduced interest rates less
than one-percent, and then kept them stable, at a pretty elevated
rate for a pretty extended period of time.
Large changes in rates, on the other hand, in either direction
are a different story. Some of the markets worst losses have
coincided with the largest declines in the Fed’s target rate –
because those large rate cuts usually occur only when there is a
large, unexpected slowing in the economy; something markets often
don’t like.
Meanwhile, we think the Fed also very much wants to avoid a
scenario where it has to start raising rates again, given the
potential confusion that this could signal after it only recently
continued to lower them. And so if over the course of this year,
the Fed does need to raise rates, given the very high bar we
think they’ve given themselves for action – it probably suggests
that something unexpected, and not in a necessarily good way, has
occurred.
Central bank policy will always matter for markets. But for
investors, the question of whether the Fed will cut once, which
is the Morgan Stanley base-case, twice, or not at all in 2025 may
not matter all that much, at least for credit. Far more important
is the performance of the economy, and whether big changes to
tariffs or immigration policy drive big changes to growth and
inflation. Those big changes, which could drive big changes in
Fed policy responses, are the scenario that worries us.
Thanks for listening. If you enjoy the show, leave us a review
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