What has happened after the Fed cut rates in a strong economy

Brad Smith
·Host
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In this article:

The Federal Reserve is trying to walk a tightrope: bring down inflation while not dragging down the overall economy too much. Most members of the Fed expect three rate cuts this year, but the timing is still questionable.

Yahoo Finance's Jared Blikre looks at when the Fed moved to cut rates in the past and what it may reveal about today.

For more expert insight and the latest market action, click here to watch this full episode of Wealth!

Editor's note: This article was written by Stephanie Mikulich.

Video Transcript

BRAD SMITH: These past two weeks, we've seen an influx of economic data from the GDP report and consumer sentiment to the upcoming jobs numbers that will come out this Friday. A hot labor print may mean the Fed doesn't rush to cut interest rates, while a weaker-than-expected headline figure could give reason to finally cut rates. We've got Yahoo Finance's Jared Blikre with us to break it all down. Hey, Jared.

JARED BLIKRE: Thank you, Brad. The name of the US economy is resilience, and that is something that has defied a lot of experts. No recession over the last year, and really nothing in sight. But we do want to assess the odds of a-- historical odds of a probability of a Fed rate cut. So the first question in my mind is, is the economy too strong to handle a Fed rate cut because the risk is is that the Fed is cutting rates in a strong economy, the economy only gets that much hotter, inflation reaccelerates, and then that gets away from the Fed.

So I went back all the way to the 1970s, and all I'm tracking here are two different things. In cyan, light blue, we have the Fed funds rate. That is the Fed's benchmark overnight interest rate. And you can see this got to 20% a few times in the 1980s, in the early 1980s under Paul Volcker, that's a 20% up here. And then scaled left here, we have the S&P 500 on a log scale.

And it's hard to see, but you will see some bear markets in there that aren't necessarily apparent to the naked eye. So, let me just go historically back in time through the previous Fed rate-cutting cycles. And all you have to do to go back in time is 2019 because that was when the Fed cut rates from 2.5% to 2.25%. So, I assessed where the economy was at this time. And guess where the ISM level was, it was 51.5. That is still in expansion territory. That is higher than the current print that we have right now of 50.3.

So, the economy when the Fed cut in 2019, according to the ISM, was stronger. Also, the unemployment rate was 3.6%, that was less than currently. GDP was 3.4%, so that was exactly where we are right now. So, with a stronger economy, the Fed cut rates. And then, guess what happened, we got a pandemic a few months later. So difficult to draw anything from that.

But all you have to do is go back to 2007 to find another example of when the Fed cut rates in a strong economy. Now, 2007 was a prelude to the global financial crisis, but we didn't know until it really happened, until Lehman Brothers failed. And that was in November, or excuse me, September of 2008. A year earlier the Fed started cutting rates, 50 basis points with the ISM level at 52.2, that's a lot stronger than it is now. 4.6% is the unemployment rate back then in 2007. That's bordering on a high number, which is not that great for the economy, but still not bad. GDP was 2 and 1/2 percent.

My point is we don't really know when a recession is coming until we're right up against it. And then the Federal Reserve, in those instances, has to drastically cut rates very quickly. But what usually happens is the Fed just kind of does it piecemeal. They feel it out. And I will say in the 1990s, we did have a couple of potential soft landings in here that you could argue in 1995 and 1998 when the Fed cut rates, and we saw the stock market accelerate and really didn't have too many hiccups because there was no recession with that.

Bottom line is we can never predict fully what the conditions are going to be that lead a Fed to cut rates or what's going to happen a year later. Anything can happen. And so I guess, unfortunately, my biggest takeaway is that we cannot predict, and we cannot say that the Fed shouldn't cut rates right now because they have historically, and it's gone either way.

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