Dollar rises, stocks slip: Will Fed’s aggressive 0.50% rate cut steer clear of a recession?

Before the US Federal Reserve announced its interest rate decision on September 18, analysts were majorly expecting a smaller cut of 0.25%. The decision comes amid growing concerns about economic conditions, with many drawing similarities between the current economy and that of 2007.

The dollar has gained as a result of the interest decision, but the top US indices have given in to profit-taking after an initial record rise.

The 0.50% cut was unexpected

Before the United States Federal Reserve was set to announce its interest rate decision, the CME FedWatch marked a 100% probability of a monetary easing. However, the analysts anticipated that it is more likely that the Federal Open Market Committee (FOMC) cut interest rates by 0.25%. However, for the first time in four years, the Fed decided to cut the rate by half a point.

Before the rate cut decision, analyst Brett noted on X that there had been similarities between the economic conditions of 2007 and 2024. It includes some key economic indicators like the unemployment rate, inflation rate, housing starts, leading economic activity, and existing home sales. Despite this, Brett said that he is not predicting a repeat of the 2007 financial crash.

However, an analysis by The Kobeissi Letter reveals that the Fed has started rate cuts with a 50 bps slash in only 2 instances earlier. Both times led to a recession. Meanwhile, the Interest rate futures predict 8 interest rate cuts in 12 months, which reportedly hasn’t happened since 2008.

Friendly reminder.

10 of the last 14 Fed rate cut cycles directly led to a Recession.

The only times they didn't – 1966, 1984, 1995, and 1998 – the economy was noticeably stronger than it was today.

Less debt. Better GDP growth. More savings. And a reduction in unemployment,… pic.twitter.com/xSYqlrl4ah

— Nick Gerli (@nickgerli1) September 18, 2024

The stocks cheered but profit-taking took over

According to data points by The Kobeissi Letter, if the Fed avoids a recession after cutting rates by 50 basis points, it would be the first time that a recession doesn’t follow. Considering big cuts signal a weak economy, rate cuts of 2001 and 2007 signaled just that. Stock markets reported a 31% and 26% decline after months of the respective cuts.

The platform also notes that history tells us that if rate cuts start with 25 bps, the S&P 500 tends to go up 10% in 3 months and 15% over a year. But if the cuts start with 50 bps, stocks tend to drop, with around a 15% decline in 12 months.

According to Reuters, the central bankers plan to lower interest rates in the range of 4.25%-4.50% by the end of 2024. The Fed is expected to make two 0.25% cuts in November and December. By the end of 2025, the report predicts by citing policymakers that the rate will drop to 3.4%, with four more small cuts next year. By 2026-2027, the rate could stabilize around 2.9% based on the predictions.

The immediate reaction to the rate cut has however been a stock market rally.

After the policy announcement, the Dow Jones and S&P 500 stock indices briefly reached record highs. However, profit-taking caused the Dow, S&P 500, and Nasdaq to end lower. The USD gained as a result of the larger-than-expected interest rate cut.

The decision also led the former Republican presidential nominee to take a dig at the independence of the Fed. Ramaswamy questions the timing of the rate cut as it precedes closely before the November elections. However, the longer term reaction of the stock market and the GDP growth will decide if the economic conditions can steer clear of a recession this time around.