Here's Why The Federal Reserve Cutting Rates Could Be A Sign Of the Next Recession.

While we often discuss the crypto markets, it’s also important not to forget about the general financial markets, which clearly have an overarching impact on everything. With that being said, whether you hold crypto or are watching from the sidelines, it’s evident that all markets have been influenced by the decisions of the Federal Reserve.

In recent years, everyone has been focused on how much and how fast the Federal Reserve would raise interest rates. However, I believe the real focus should be on when they start cutting rates, as this signals that things have gone wrong.

Stock Market During Previous Rate Cuts

In late 2008, the Fed slashed rates to zero in an unprecedented attempt to help the U.S. economy cope with the fallout from the 2008 global financial crisis. In 1998, the Alan Greenspan-led Fed cut interest rates to combat an economic downturn and sustain the expansion.

Both of these moves were followed by a large recession but were subsequently followed by continued growth. The market has grown substantially since, and it only saw a minor blip crash during the 2020 COVID crisis, yet it has not entered into a real lengthy market recession, which is a normal cycle, and which the Federal Reserve is clearly trying to artificially avoid, so China doesn’t surpass the U.S economy.

Fed Chair Jerome Powell, in his recent speech at Jackson Hole, specifically noted the conditions under which the Fed would raise rates further, implying

that future rate increases are perhaps no longer a foregone conclusion.

In the history books, a Fed rate cut usually occurs when the economy is shaky, and the stock market is behaving unpredictably. It's the Fed's way of saying, "Hey, let's try to kickstart things and get the economy moving." But here's the catch: after a rate cut, things can get worse before they get better. It's like slamming the brakes on a train—it takes time to stop and then start moving in the right direction.

However, unlike the last few decades, a lot has changed. These days, more of us are buying and trading stocks using our smartphones. That's a game-changer. It means information travels super fast, which can make markets react differently to Fed rate cuts. This could be a bad thing, leading to quicker fear in the markets and even greater capitulation, but this is all speculation, and only time will tell.

Another thing to keep in mind is that while we still have forward-thinking investors nowadays, we cannot ignore the fact that retail investors have crowded the investing space at a larger rate than ever before. Everyone and their grandma is trading stocks on the side to make extra money, which can further induce volatility.

Bubbles Everywhere.

Hundreds of stocks have surged by billions and are inching towards all-time highs right now. Nearly all major banks are predicting that prices will surge even higher, and retail investors are more exposed to the markets than ever.

Times like this are only apparent during bubbles, where greed surpasses logical thinking and investors make irrational decisions. This can be known as 'irrational exuberance,' which refers to investor enthusiasm that drives asset prices higher than the fundamentals of those assets justify. The term was popularized by former Fed Chair Alan Greenspan in a 1996 speech.

The Risk of a Recession Remains High

The real test for the Fed would come if the U.S. entered a recession. That’s something the U.S. economy has avoided for now, but some metrics, such as the yield curve, are calling for a 2024 recession.

The Fed will face a real trade-off between price stability and job creation. So far, they have stressed the importance of price stability to the economy, but in the face of a recession, that belief may be harder to sustain.

When Can We Expect the Next Rate Cut?

Wells Fargo analysts predicts we will see a rate cut next year:

For now, the rates are expected to remain high for some time. I agree that we will start to see incremental rate cuts either near the end of this year or in 2024, which aligns with market and Fed forecasts. Still, history suggests that once the Fed starts cutting interest rates, further cuts can come quickly, especially if the economy weakens.

The Federal Reserve analyzes economic data and indicators as it formulates monetary policy decisions. If you're curious about the reasons behind potential rate cuts, they typically arise from growing concerns related to critical economic factors that could signify challenges ahead.

Slowing Economic Growth: A slowdown in GDP growth raises concerns. When businesses invest less, exports drop, or consumers spend less, it's a red flag. Rate cuts can spur spending and investment, promoting growth.

Rising Unemployment: High unemployment can harm the economy. Rising joblessness can lead to cautious consumer spending. Lower rates encourage businesses to create jobs and consumers to spend more.

Declining Consumer Spending: Consumer spending drives our economy. Reduced spending due to personal debt or economic uncertainty can stifle growth. Rate cuts aim to boost borrowing and spending.

Inflationary Pressures: The Fed aims for stable prices. High inflation erodes purchasing power, while low inflation can signal weak demand. Rate cuts can combat stagnation and deflation.

Global Economic Conditions: Global events affect us. Trade tensions, financial crises, and geopolitical events can impact the U.S. economy. Rate cuts can help shield against external shocks.

Using futures to anticipate Fed rate cuts in 2024-25

We've tracked the changing expectations for US interest rates over the past year and a half. Despite a strong economy during a period of consistent rate hikes, the anticipated shift in Federal Reserve policy has continuously been postponed.

The chart below uses futures contracts to estimate the expected US effective Fed Funds rate for the next 18 months. It also illustrates the projected number of rate hikes and cuts on the right-hand side (assuming each change is uniform at 0.25 percentage points).

A significant policy shift isn't foreseen until at least late spring. Furthermore, as 2025 begins, the Fed's benchmark rate is still expected to be above 4 percent – a level that many didn't anticipate just a year ago.

As we look ahead to potential Federal Reserve rate cuts, it's essential to keep a close eye on critical economic indicators such as growth, employment, spending, inflation, and global events. The effects and timing of these rate adjustments can be uncertain, especially in today's rapidly changing economy. While concerns about a looming recession persist, the future remains uncertain.

We'd love to hear your thoughts! Do you believe the Federal Reserve will successfully maintain market stability, or do you anticipate that the clearly overvalued mega-bubble might burst, potentially triggering a prolonged recession?

Share your insights with us! 🐋