Markets & Economy

The Federal Reserve is meeting today, amid widely-held expectations that they will be cutting interest rates over the next 12-18 months.

Typically, the Fed lowers rates to spur growth in the face of a slowdown. In fact, it has been more than 20 years since they have cut rates outside of what would become a recession cycle. The last time the Fed lowered rates without a recession soon following was in the mid-1990s.

Rate Cuts Usually Align With Downturns

Source: Bloomberg. Analysis Manning & Napier.

Some people are drawing parallels between today’s environment and the circumstances surrounding a call the Fed made in July 1995. At that time—as well as in December 1995 and January 1996—officials cut rates to provide ‘insurance against recession.’ In other words, the Fed was hoping to stimulate growth to stave off a downturn it saw on the horizon.

Similarly, many are speculating that today’s Fed is also looking to avoid a recession before it happens. In recent quarters, economic growth has slowed considerably. Job creation is notably down, and simmering trade tensions have investors on edge.

Although an interest rate reduction may seem necessary, the decision isn’t always clear. The Fed must also balance its goal of stimulating economic growth with controlling inflation. Fortunately, inflation has been consistently below the Fed’s 2% target through most of the past decade, and it remains so today. Low inflation will make any decision to lower rates an easier one.

Still, the mid-1990s comparison is not perfect. Like back then, today’s economic data is also mixed, but the delicate trade situation represents a high stakes source of uncertainty. Additionally, the Fed’s target rate sat at 6% in 1995, versus the current 2.25-2.5% range. If the Fed decides to reduce interest rates and the economy enters a recession anyway, then they will have less wiggle room to continue lowering rates in the future.

There are a few possible outcomes over the next several months (in no particular order):

• If the economy gets worse, we would expect interest rates to be lowered back down to ultra-low levels.
• If the economy turns around, the Fed is likely to hold firm with few, if any, interest rate cuts.
• If the economy remains mixed, the Fed would be likely to attempt a soft landing. This means that the central bank would look to tactically lower interest rates to prevent a full scale recession, but not lower them so much as to eliminate all their wiggle room. In this scenario, the market expectation for 2-4 rate cuts in the next 18 months would be on track.

It remains to be seen whether today’s risks warrant the first rate cut in a decade. Even if the Fed does not pursue monetary easing at this week’s meeting, there is still a high probability that they will later in the year.

If rates decline, there may be less value in owning long-term bond securities, and it is possible that we would look to reduce our longer maturity bond positions. Regardless of where interest rates and the economy ultimately land, we will remain flexible and nimble to take advantage of buying opportunities.