A questionable interest pill
The interest rate cut in August was explained by Federal Reserve Chairman Jerome Powell as a preventive mid-cycle policy adjustment, due to concerns about the future of the economy. It would not be the start of a series of interest rate cuts, indicating the end of the economic cycle. However, I have my doubts whether a quarter of a percentage point less will suffice in that case.
Every time the interest rate curve inversed, this led to a recession and a major correction in the stock markets. On average, there are 15 months between an inverse interest curve and a recession. Investors don’t wait for the economic downturn. The stock market peaks on average five months before the recession starts. Fasten your seat belts, it’s getting rough.
Policy interest rate too high
Fifteen months is an average; this period can also be shorter or longer. The Federal Reserve is investing in a longer period by explaining the interest rate cut as a temporary adjustment. A safeguard from worse, as was the case in 1995 and 1998. At both times, a reduction of the policy rate with 75 basis points was enough to prevent a recession. In 1995 the interest rate was cut, while the S&P 500, just like now, flirted with records. The term structure was also inverse in 1998. But here the comparisons end.
The big difference is that business is uncertain and more cautious. Uncertainty does not disappear with an interest rate cut. Profit margins in business are under pressure. Investments are being postponed and job growth is levelling off. We are approaching the moment of cost cutting. Even when, like in 1995 and 1998, another 50 basis-point interest rate cut would occur, the curve would still be inverse. I bet that the peak in the financial markets is closer than we think.