The Truth About Interest Rate Cuts
Summary
TLDRThe video discusses the Federal Reserve's decision to cut interest rates, marking a shift from tightening to easing monetary policy. It explores historical rate cut cycles since 1990, categorizing them into four types based on economic conditions and events. The video analyzes how these cycles affected the stock market, with an average one-year return of 11.8% and a 10-year return varying significantly. It concludes by emphasizing the unpredictability of recessions and the importance of understanding past rate cut scenarios for future economic expectations.
Takeaways
- đ The Federal Reserve's first rate cut in several years marks a shift from a tightening monetary policy to a more stimulative stance.
- đ Historically, rate cuts have often been followed by recessions, but not always, with only four out of eight rate cut cycles since 1990 leading to recessions.
- đïž The Fed cuts rates for various reasons, including in response to economic events, to prevent deflation, or to adjust policy in the face of economic weakness.
- đ In the past, investing in the stock market during rate cut cycles has often been profitable, with an average one-year return of 11.8%.
- đ The 1990 rate cut was a response to the oil price shock caused by Iraq's invasion of Kuwait, leading to a significant reduction in rates over two years.
- đ The 2001 rate cuts were a reaction to the bursting of the Internet stock market bubble, with the market falling before the Fed intervened.
- đ„ The 2007 rate cuts were initiated in response to the housing bubble and the subsequent financial crisis, beginning a few months before the recession.
- đ The 1998 rate cut was unique, occurring during a period of economic strength but in response to the Asian financial crisis and its global impacts.
- đ The 2002 and 2009 rate cuts were minor policy adjustments in response to concerns about slow economic progress and potential deflation.
- đ The 1995 rate cut was a midcycle adjustment to maintain economic balance after a period of aggressive rate increases.
Q & A
What was the main decision made by the Federal Open Market Committee in the video?
-The Federal Open Market Committee decided to reduce the degree of policy restraint by lowering the policy interest rate by a half percentage point.
What does the term 'rate cut' mean in the context of the video?
-A 'rate cut' refers to the Federal Reserve's decision to lower interest rates as part of its monetary policy, which is aimed at easing monetary policy and stimulating the economy.
How many official US recessions have occurred since 1990, and what is the common timing with the Fed's interest rate cuts?
-Since 1990, there have been four official US recessions, each of which came shortly after the Fed began cutting interest rates.
What are the four reasons the Federal Reserve might cut interest rates as mentioned in the video?
-The four reasons the Federal Reserve might cut interest rates include: 1) a reaction to a recession-causing economic event, 2) a response to an economic event without a subsequent recession, 3) minor policy adjustments due to economic weakness, and 4) a midcycle adjustment to keep the economy balanced.
What economic conditions led to the Fed cutting interest rates in June 1990?
-In June 1990, the Fed cut interest rates in response to the 1990 oil price shock caused by Iraq's invasion of Kuwait, which caused oil prices to spike significantly.
What is a 'type one circumstance' for interest rate cuts as described in the video?
-A 'type one circumstance' for interest rate cuts is when the Federal Reserve cuts interest rates as a reaction to a recession-causing economic event, which is the most common type of rate cut cycle in the past 30 years.
What was unique about the 1998 rate cut cycle, and how does it differ from a type one rate cut?
-The 1998 rate cut cycle was unique because it occurred when the economy was in good shape, with low and falling inflation and unemployment rates. It differed from a type one rate cut as it was not followed by a recession, and the Fed was reacting to an economic event (Asian financial crisis) without a US recession.
What are the characteristics of a 'type three' rate cut cycle?
-A 'type three' rate cut cycle is characterized by minor policy adjustments due to economic weakness rather than responding to a large economic shock. It involves the Fed seeing inflation falling too much and unemployment staying too high, leading to small changes in rates to stimulate the economy.
Can you explain the 'type four' rate cut scenario mentioned in the video?
-The 'type four' rate cut scenario refers to a midcycle adjustment where the economy is fundamentally sound, but the Fed makes minor rate cuts to maintain balance and prevent deflation or to ensure continued economic growth without overheating.
What is the average one-year performance of the stock market following the first rate cut in each cycle since 1990?
-On average, the one-year performance of the stock market from the first cut in each cycle since 1990 has been 11.8%.
How does the video suggest the stock market has performed over the long term after rate cut cycles?
-If you bought stock when the Fed first cut rates in each cycle since 1990, on average, your return would have been 5.03% per year for the next 10 years, with a wide variety of outcomes depending on the specific cycle.
Outlines
đ Federal Reserve's Rate Cuts and Economic Impact
The video discusses the Federal Reserve's decision to lower policy interest rates by 0.5%, marking a shift from a tightening monetary policy to a more stimulative stance. Historical context is provided, noting that since 1990, four US recessions have followed rate cuts, but not all rate cut cycles lead to recessions. The video outlines four reasons why the Federal Reserve might cut rates, with a focus on the circumstances surrounding previous rate cut cycles. The 1990 oil price shock and the subsequent rate cuts are highlighted, showing how rate cuts can be a response to economic events without necessarily leading to recession. The video also suggests that the current rate cut scenario does not resemble a 'type one' rate cut, which is typically a response to a recession-causing event.
đ The Rare 'Type 2' Rate Cut Cycle of 1998
This section delves into the unique 'type 2' rate cut cycle of 1998, which occurred during a period of economic stability with low inflation and unemployment rates. The Federal Reserve's rate cuts were a response to the Asian financial crisis and its ripple effects, including a drop in oil prices. Despite the rate cuts, the US did not enter a recession following this cycle, distinguishing it from 'type 1' cycles. The video also mentions the 'daily upside' newsletter as a resource for staying informed about financial news, including the current market's expectations for further rate cuts, which might be indicative of a potential recession.
đŒ Types 3 and 4 Rate Cuts: Economic Adjustments and Midcycle Soft Landings
The video continues by examining 'type 3' rate cuts, which are minor policy adjustments in response to economic weakness rather than a major shock. Examples include the 2002 and 2009 rate cuts, aimed at combating deflation and supporting a recovering economy. 'Type 4' rate cuts, such as those in 1995, are described as midcycle adjustments to maintain economic balance. The Federal Reserve's 1995 rate cuts are highlighted as a successful 'soft landing,' where aggressive rate hikes were followed by minor cuts to sustain economic growth without leading to a recession. The video concludes with a discussion on stock market performance following rate cut cycles, noting the variability of short-term returns but a generally positive long-term trend over the next 10 years.
Mindmap
Keywords
đĄFederal Open Market Committee (FOMC)
đĄInterest Rate Cut
đĄMonetary Policy
đĄRecession
đĄInflation
đĄUnemployment Rate
đĄStock Market
đĄEconomic Shock
đĄMidcycle Adjustment
đĄSoft Landing
đĄDerivatives Traders
Highlights
The Federal Reserve announces its first rate cut, signaling a shift from tightening to easing monetary policy.
Since 1990, four US recessions have followed rate cuts, but not all rate cut cycles lead to recessions.
There are four reasons why the Federal Reserve cuts interest rates, each with different implications for the economy.
In June 1990, the Fed cut rates in response to the oil price shock caused by Iraq's invasion of Kuwait.
Investing in the stock market at the start of the 1990 rate cuts led to a 15% decline initially, followed by a recovery.
Type one rate cut circumstances occur when the Fed cuts rates in reaction to a recession-causing economic event.
The 2001 rate cuts were a response to the bursting of the Internet stock market bubble.
The 1998 rate cuts were unique, as they were not followed by a recession despite being a response to an economic event.
Type two rate cuts are rare and occur when the economy is in good shape but faces external economic shocks.
Type three rate cuts are minor policy adjustments due to economic weakness rather than a large shock.
The 2002 and 2009 rate cuts are examples of type three, aimed at preventing deflation and supporting economic recovery.
Type four rate cuts are midcycle adjustments to keep the economy balanced, like the 1995 rate cut cycle.
The 1995 rate cut cycle was a soft landing, where the Fed eased policy after successfully raising rates to combat inflation.
The Fed's 2024 rate cuts resemble type three and type four cycles, aiming for a soft landing without a recession.
On average, the stock market has seen positive returns during rate cut cycles, but outcomes vary widely.
Long-term stock market returns after rate cuts have varied, with the best period following the 1990 cuts and the worst following 1998.
The video emphasizes the unpredictability of recessions following rate cuts and the importance of understanding historical contexts.
Transcripts
today's video is sponsored by the daily
upside there a completely free daily
newsletter more on this later in the
video the Federal Open Market Committee
decided to reduce the degree of policy
restraint by lowering our policy
interest rate by a half percentage Point
Drome pal has finally done it the
Federal Reserve just announced its first
rate cut pivoting its monetary policy
from the tightening restrictive stance
we've seen over the past 2 years to a
cycle of rate Cuts easing monetary
policy and stimulating the economy pop
the campaign it's time to
celebrate or is it since 1990 there have
been four official us recessions and
each of them came shortly after the FED
began cutting interest rates that
certainly doesn't sound very good except
there's been eight rate cut Cycles
during that period only four of them
were followed by a recession that's
because there isn't just one reason why
the Federal Reserve Cuts interest rates
in fact there's four reasons
so to understand what might happen to
the stock market or the economy in the
current rate cut cycle we need to
understand the circumstances that
surrounded the previous ones let me take
you back to June 1990 inflation was 4.7%
which is high it sits well outside the
generally agreed 2 to 3% healthy range
but it had been coming down the
unemployment rate was steady at around
52% and the US was not in recession so
then why did the fed start cutting rates
the Central Bank started shifting its
monetary policy in response to the 1990
oil price shock Iraq invaded one of the
OPEC countries called Kuwait causing oil
to spike from $17 in July 1990 to $39 by
September that year so the FED cut
interest rates from 8.25% in July 1990
to 3% in September of 1992 a total of
525 basis points over 2 years even
though it wasn't known at the time a
recession started the same month that
the rate Cuts began lasting until March
of 1991 the unemployment rate Rose
significantly and inflation fell if you
had invested in the stock market when
the FED started cutting rates you would
have experienced a 15% decline within
the first 6 months followed by a sharp
recovery and 1 year later you would have
been up almost 9% this is what I'll call
a type one circumstance for interest
rate cuts when the Federal Reserve Cuts
interest rates as a reaction to a
recession causing economic event this is
the most common type of rate cut cycle
of the past 30 years four of the eight
cutting Cycles are type one in 2001 for
example the Fed rate Cuts came in
response to the bursting of the Internet
stock market bubble the stock market
peaked in early 2000 and fell 12% before
the FED stepped in and began cutting in
January of 2001 they cut a total of 475
BAS B points throughout 2001 as the dot
bubble continued to unravel and after
the September 11 terrorist attacks
you'll notice that the Fed rate cut
started a few months before the actual
recession and the same was true in 2007
the FED started that rate cut cycle in
September of 2007 3 months before the
recession started but while these rate
Cuts came before the actual recession
period they were still made in reaction
to an economic shock in 199 it was the
oil crisis in 2001 it was the tech
bubble bursting and in 2007 it was in
response to the housing bubble beginning
to pop and in the last type 1
circumstance it was a reaction to the
spread of covid-19 and the collapse of
the stock market without additional
context it looks like the FED Cuts rates
and shortly after a recession begins but
in all of these circumstances there was
already a widespread economic event
taking place the Fed rate cut today is
not in response to one of the events so
we're not a type one rate cut scenario
that's certainly not to say that it
can't turn into one very quickly but at
least as of today there are much better
examples from the past of rate cut
cycles that better match what we're
seeing in 2024 and gives us a better
window into what to expect for the stock
market and the economy from here a quick
pause in the video I just want to share
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description while the type one rate cut
Cycles get talked about the most I think
the type 2 category is far more
interesting there's only been one of
them in 35 years and it happened in 1998
at the time the economy was in great
shape inflation was extremely low and
falling the unemployment rate was just
4.5% and also falling and the US was not
in a recession but just like the rate
cut Cycles we've spoken about the FED in
this case was also reacting to an
economic event beginning in 1997
Thailand was facing a currency crisis
they were burdened with a huge amount of
foreign debt and couldn't make payments
because their currency was pegged to the
US dollar after being forced to unpeg
their currency it collapsed and the pain
spread to other Southeast Asian
countries and then to Japan and South
Korea as their currencies collapsed too
the spread of crippling economies across
Asia also slowed the demand for oil
contributing to its price falling
sharply while all of this was happening
outside of the US American markets were
affected the S&P falling 14% from a peak
in April 1998 to July in September and
until November the FED cut interest
rates by 75 basis points so far it
sounds like this fits within the type
one category but what makes this one
different is that there was no us
recession that followed it's less common
but even if the FED is cutting rates in
response to an economic event it doesn't
always lead to a recession but again
there is no economic event or shock that
the FED is reacting to in 2024 so
today's rate cuts are also not like 1998
today's rate cuts are much more similar
to type 3 and type four Cycles there
have been two type 3 rate cut Cycles
since 1990 the first was in 2002 the US
was now out of its 2001 recession and
unemployment had stopped Rising settling
below 6% the economy was recovering but
the FED felt that the progress was too
slow inflation in particular was a
concern it sat around 2% but there was
concern it could continue to decline and
turn into deflation lower prices might
sound pretty good but it can quickly
turn into a very vicious downward spiral
that can be very very hard to get out of
so starting in November 2002 the FED cut
rates for a total of 75 basis points
this turned out to be the bottom of the
stock market with the S&P 500 rising
133% in the year after the first cut and
the economy continued its recovery no
recession after the rate cutting cycle
2002 and also 2009 fall into type three
minor policy adjustments due to economic
weakness rather than responding to a
large economic shock it's the FED seeing
inflation falling too much and
unemployment staying too high so they
make a small change to rates you could
make a good argument that the rate Cuts
we're seeing today fits into this
category today's Cuts also fit into the
type four category which is my favorite
so I've saved it to last but we'll get
to that in a minute today's economy by
the headline figures is in great
condition but it's potentially weakening
prices on average are 23% higher than
preco and for a lot of items it's much
worse the annual inflation rate now is
just
2.6% that's in the healthy 2 to 3% range
but it has been falling quickly and it's
possible the FED is concerned about
letting us fall into deflation much like
their concerns in 2002 the unemployment
rate is also very good 4.2% but since
2023 it has been rising as businesses
contend with supply side inflation but
as I mentioned earlier today's
environment looks a lot like the type
four rate cut scenario it's only
happened once in the last 30 years and
it gets so little attention that you
probably didn't even know it occurred
this rate cut cycle happened in 1995
inflation was around 3% the unemployment
rate was falling but still a little high
in the mid 5% but for the most part
conditions were pretty good so why did
the FED cut interest rates by a total of
75 basis points well this is what the
FED likes to call a midcycle adjustment
in their July 1995 meeting they said as
a result of monetary tightening
initiated in early 1994 inflationary
pressures have receded enough to
accommodate a modest adjustment in
monetary conditions in the early '90s
the US was experiencing an economic boom
and sometimes when this is the case the
FED likes to raise interest rates they
do this to prevent the economy from
getting too hot and creating High
inflation but also because the higher
the interest rates are when an economic
shock hits the more room they have to
lower them and stimulate the economy
after a short stint of rate increases
the FED made some minor rate Cuts again
to keep the economy in Balance this is
another example of a Fed rate hike and
cutting cycle that didn't lead to a
recession something you might have heard
called a soft Landing this 1995 soft
Landing is what the FED is hoping to
achieve in 2024 they raised interest
rates aggressively to combat inflation
and successfully brought it back into a
healthy range so it's appropriate for
them to now ease monetary policy and
pray that they've nailed the policy
adjustments I'm going to talk about how
the stock market has performed in the
shortterm and long term after each of
these rate cut Cycles in a minute but
this is a good spot in the video I think
to State the obvious which is there's no
way anybody can know if there's going to
be a recession say next year it's
possible of course but hopefully by
going through some of the past rate cut
Cycles we can see there are a variety of
possible outcomes some good and some bad
okay let's take a look at stock market
returns so there's been eight rate cut
Cycles since 1990 on average the
one-year performance from the first cut
in each cycle has been
11.8% so on average it's paid to be
invested during The Cutting cycle but
there have been a wide array of results
spanning from negative 24% in 2007 to
Plus 54% in 2020 who would have guessed
it short-term returns vary a lot but
what about long-term returns well if you
bought stock when the FED first cut
rates in each cycle on average your
return would have been
5.03% per year for the next 10 years
oddly that's actually not that good but
again it's because there's a wide
variety of outcomes the best 10-year
period came after the 1990 cut you would
have earned a 14.9 9% per year return
the worst was 1998 your 10-year return
was
2.58% per year if you bought stock in
1998 even 10 years later you would have
been down but held on to today and
you've done extremely well which I think
is a nice reminder that the stock market
is great but it is a long-term wealth
vehicle subscribe if you enjoyed the
video and consider checking out one of
these videos next
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