Federal Reserve might’ve set America on a course to recession with the rate cut

The Federal Reserve’s decision to slash interest rates by 50 basis points yesterday has folks wondering whether it could lead to another recession. 

The last two times they cut rates by more than 50 basis points, the economy fell into recession a few months later.

History is not on the Fed’s side

The first time was on January 3, 2001. The result? Over the next 448 days, the S&P 500 dropped nearly 39%, and unemployment jumped by 2.1%.

The recession that followed was tied to the dot-com bubble bursting and was made worse by the September 11 attacks.

Then, on September 18, 2007, they did it again. Another 50 basis points cut, and the S&P 500 plunged by 54% in the following 372 days. 

Unemployment surged by 5.3%. The recession lasted until mid-2009, made worse by the housing market collapse and a global financial crisis.

But here’s the thing. This time around, the signs are a little mixed. Inflation has eased, falling below 5% in August. 

The Fed’s target is 2%, and its policy committee believes they’re on the right track with the recent adjustments. But the labor market is in trouble. Unemployment has risen to 4.3% in August from 4.1% in June, the highest rate in three years. Despite it though, unemployment is still relatively low compared to past recessions.

GDP growth in Q2 hit an annualized rate of 3.0%, a sharp increase from the modest 1.4% growth in Q1. But economists predict that it could slow to around 0.6% in Q3, as high prices and high interest rates put a squeeze on consumer spending. 

The Fed’s goal to achieve a soft landing might be harder than they think. Comparing the current economic indicators with those from 2001 and 2007 adds to the concerns. 

In September 2024, the Federal Funds Rate is between 4.75% and 5.00%. Before the 2001 recession, it was around 6.5%. Before 2007, it was about 5.25%. Unemployment now is at 4.3%. It was 4.0% before 2001 and 4.6% before 2007.

Despite these parallels, some factors suggest a recession isn’t certain. The Fed argues that the risks are balanced. They see the labor market and inflation as stable, unlike the past when severe imbalances led to economic collapse.

Still. History shows that rate cuts of this size have ALWAYS led to a recession. If the Fed manages to avoid one, it would be the first time ever.

Markets show initial positivity, crypto, quite not

The stock market is often a leading indicator of the economy’s health. After the 2001 rate cut, the S&P 500 fell nearly 40%. The Nasdaq lost about 80% of its value. The market panic was made worse by corporate scandals like Enron and the September 11 attacks. It took years for the market to recover.

In the 2007-2009 recession, the S&P 500 dropped around 57%. The financial crisis led to massive sell-offs, and major institutions needed government bailouts. Investor confidence was shattered. The recovery was slow and painful, with many stocks not regaining their pre-crisis levels for almost a decade.

Yesterday, the market initially reacted positively to the cut. But this optimism could be short-lived.

Meanwhile, crypto markets did not react the way investors hoped. Ether couldn’t even make a break to $2,500 and Bitcoin only managed to hit $62k from $60k. Not quite the big bullish catalyst we were hoping for.

So, what could happen now? Over the next 3 to 6 months, if unemployment keeps rising and consumer spending dips, a recession could start.

If current trends persist, a gradual slowdown could lead to a recession in 6 to 12 months.

On the other hand, if conditions stabilize, with consumer spending and inflation under control, the US economy might dodge a downturn.