The Truth About Interest Rate Cuts

Summary

The 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

• 📉 The Federal Reserve's first rate cut in several years marks a shift from a tightening monetary policy to a more stimulative stance.
• 🔍 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.
• 🏛️ 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.
• 📈 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%.
• 📊 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.
• 📉 The 2001 rate cuts were a reaction to the bursting of the Internet stock market bubble, with the market falling before the Fed intervened.
• 🏥 The 2007 rate cuts were initiated in response to the housing bubble and the subsequent financial crisis, beginning a few months before the recession.
• 🌐 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.
• 🔄 The 2002 and 2009 rate cuts were minor policy adjustments in response to concerns about slow economic progress and potential deflation.
• 🛑 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

00:00

📉 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.

05:01

📈 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.

10:02

💼 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.

Keywords

💡Federal Open Market Committee (FOMC)

The Federal Open Market Committee is a part of the Federal Reserve System responsible for setting monetary policy in the United States. In the video, the FOMC's decision to lower the policy interest rate by half a percentage point is discussed as a pivotal moment in the monetary policy cycle, indicating a shift from tightening to easing monetary policy to stimulate the economy.

💡Interest Rate Cut

An interest rate cut refers to a reduction in the interest rates set by a central bank, such as the Federal Reserve. In the context of the video, the rate cut is analyzed as a tool used by the Fed to stimulate economic growth by making borrowing cheaper and encouraging investment and spending. The video discusses the implications of such a cut on the stock market and the economy.

💡Monetary Policy

Monetary policy refers to the actions of a central bank, such as the Federal Reserve, intended to influence economic activity, primarily through the setting of interest rates and the management of the money supply. The video discusses the shift in monetary policy from tightening to easing, which is a strategic move to manage inflation and economic growth.

💡Recession

A recession is a significant decline in economic activity that lasts more than a few months, typically visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. The video script mentions that historically, rate cuts by the Fed have often been followed by recessions, but it also points out that not all rate cut cycles lead to recessions.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, the purchasing power of currency is falling. In the video, inflation is discussed as a key economic indicator that the Federal Reserve monitors and responds to through adjustments in interest rates, aiming to maintain a healthy range of 2 to 3%.

💡Unemployment Rate

The unemployment rate is the percentage of the total labor force that is unemployed but actively seeking employment. The video discusses how the unemployment rate, along with inflation, is a critical economic indicator that influences the Federal Reserve's decisions on interest rate adjustments.

💡Stock Market

The stock market is a place where shares of publicly traded companies are issued and traded. In the video, the performance of the stock market following rate cuts is analyzed, with the script providing historical data on how the market has reacted in the past to such monetary policy changes.

💡Economic Shock

An economic shock refers to an unexpected event that disrupts the normal functioning of an economy. The video discusses how the Federal Reserve has historically reacted to economic shocks, such as the oil crisis in 1990 or the tech bubble bursting in 2001, by adjusting interest rates to stabilize the economy.

💡Midcycle Adjustment

A midcycle adjustment refers to a change in monetary policy that occurs between the peaks and troughs of the economic cycle. The video mentions the 1995 rate cut cycle as an example of a midcycle adjustment by the Federal Reserve, aimed at maintaining a balanced economy without leading to a recession.

💡Soft Landing

A soft landing refers to a scenario where an economy slows down without falling into a recession, often after a period of rapid growth. The video suggests that the Federal Reserve's current rate cuts are part of an attempt to engineer a soft landing, where they have previously raised rates to combat inflation and are now easing policy to sustain economic growth.

💡Derivatives Traders

Derivatives traders are individuals or institutions that trade financial derivatives, which are contracts derived from underlying assets. The video script notes that derivatives traders are pricing in a significant amount of rate cuts by the end of the year, which could be an indicator of expectations for a potential recession.

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

with you an incredible free resource for

staying up to date with the business

world the sponsor of today's video the

daily upside they're a completely free

daily newsletter with over 1 million

investors subscribed including myself

it's really easy to sign up and with

just 5 minutes each morning you'll be

able to get up to speed on the top

finance and investing news including

insights analysis and Clarity on the top

business story circling the globe I've

been a long time and Avid Reader of

their newsletter not only because it

helps me to stay up to date but they

always have unique details in stories

that I don't find in traditional media

such as the fact that derivatives

Traders are now pricing in 250 basis

points of rate cuts by the end of the

year which would likely only happen if

the Fed was reacting to a recession

again it's completely free to sign up

and you'll receive one information

filled email each morning join over 1

million people who trust the daily

upside sign up using the link in the

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

[Music]