The Deep Rate Cut Debate

Fed fund futures are pricing in a 25% chance of a 50 basis point (0.50%) rate cut at the Fed’s July meeting. In Fed Chair Jerome Powell’s July 10 Congressional testimony, a congressperson asked what economic factors would justify a 50 basis point rate cut. Powell effectively dodged the question, saying that policymakers look at a broad range of data when making rate decisions. Still, the idea of a steep rate reduction has gone mainstream.

It’s no secret that the Fed has prepared investors for a July rate cut, a move that was heavily implied when “patient” language was removed from the June meeting statement. We’d be surprised to see a rate cut larger than 25 basis points (0.25%), though.

As shown in the LPL Chart of the Day, Deeper Rate Cuts Typically Occur Around Recessions, the Fed has historically reserved steep rate cuts for dire economic situations. Since 1990, the Fed has implemented 18 cuts of 50 basis points or more. Only seven of those cuts happened in economic expansions, and six of those seven cuts were in the 12 months before or after a recession had started or ended.

The fed funds rate is also historically low. Cutting rates by 50 basis points right off the bat would cull the upper bound fed funds rate to 2%, leaving policymakers little wiggle room to reduce rates further when a recession inevitably materializes.

“Inflation is low, and the yield curve is indicating that monetary policy may be too tight for the uncertain trade environment,” said LPL Research Chief Investment Strategist John Lynch. “Economic fundamentals are still sound, so we view any Fed cuts at this point as a course correction, not a reaction to recessionary signals.”

As mentioned in our Midyear Outlook 2019, the Fed may go further and choose to lower rates to provide a buffer against rising risks from trade and geopolitical uncertainty, even if not fully merited by the data. The Fed remains data dependent, though, and U.S. data appear to show low odds of a recession in the near term.

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