At its September meeting, the Fed cut interest rates by 50 basis points, leaving many market participants wondering if the move signals an impending recession and a potential stock market downturn. The key may lie in the different types of rate cuts. This article breaks down two distinct rate cut scenarios to help you understand the potential implications for market trends.

I. Two Types of Rate Cuts

Since the 1980s, the U.S. has seen seven rate-cutting cycles, which can be broadly categorized into:

Preemptive Rate Cuts: These are precautionary policy moves where the central bank lowers interest rates before an economic downturn actually materializes, aiming to mitigate potential downside risks. At this stage, the economy remains relatively stable, with no significant rise in unemployment, but the Fed may anticipate potential risks such as slowing growth, rising external risks, or persistently low inflation, prompting the central bank to take action to prevent further deterioration of these risks.
Recessionary Rate Cuts: Aiming to stimulate economic activity, these rate cuts are undertaken when the economy is already in a recession. During a recession, business investments and consumer spending tend to fall, leading to stagnant or declining economic growth. By reducing borrowing costs through interest rate cuts, the central bank seeks to encourage businesses to invest and consumers to spend more, with the goal of achieving economic recovery.

II. Market Performance Under Different Rate Cut Scenarios

Looking back, periods like 1984~1986, 1995~1996, 1998, and 2019 were characterized by preemptive rate cuts. During these times, as the economic outlook remained positive, the stock market generally rallied following rate cuts with increased liquidity. And even if economic growth eventually slowed, the result was usually a “soft landing” or “no landing” scenario.

In contrast, monetary easing that took place during 1989~1992, 2001~2003, 2007~2008, and 2020 were recessionary rate cuts. Since the U.S. economy was already in a recession, the immediate effects of rate cuts were often muted. Consequently, the stock market continued its downward trend after the rate cuts, and the economy typically ended up with a hard landing.

MM Research Insights

With the Fed’s 50-basis-point cut in September, a new rate-cutting cycle has begun, with the latest dot plot projecting further reductions of as much as 250 basis points in this cycle. So, is this a preemptive or recessionary easing round?

Looking at recent economic data in the U.S., the labor market has shown some signs of weakness, with unemployment at 4.2% in August and the Sahm Rule being triggered for two consecutive months, raising concerns in the market that this rate-cutting cycle is recession-driven. However, other indicators such as retail sales and the industrial production index have continued to reach new highs or remained resilient. Thus, it’s still too early to declare the ongoing rate-cutting cycle as recessionary. In fact, the S&P 500 reached an all-time high following the Fed’s decision.

What’s your take? Is the latest rate cut preemptive or recessionary? Will the Fed succeed in steering the economy to a soft landing? Share your views in the polls and comments below!

Spotlight

More Spotlights...