Summary
- The last two recessions were preceded by Fed rate cuts.
- Stock market reactions were somewhat different in the two recessions.
- In the early 2000s recession (March 2001 to November 2001) the stock market was already going down by the time the Fed started cutting rates, and continued going down.
- In the Great Recession (December 2007 to June 2009) the stock market reaction to the Fed cutting rates was more optimistic, with a three-month rally that saw the S&P 500 go up by a little less than 10 percent.
- After that initial rally, the stock market dropped by more than 50 percent (in early 2009), with several “sucker rallies” in between.
- Generally speaking, a Fed rate cut at a period when the signs of an upcoming recession are pilling up should be a source of concern for stock market investors.
The last two recessions were preceded by Fed rate cuts
The graphs below are for the period from January 1999 to June 2019, and were generated using Yahoo Finance and the US Federal Reserve Economic Data (FRED) (, ). The graph at the top shows the weekly variation in the S&P 500 index together with its 50-month simple moving average. The graph at the bottom shows the effective federal funds rate.
As you can see, the last two recessions were preceded by Fed rate cuts. The dashed lines suggest that stock market reactions were somewhat different in the two recessions. In the early 2000s recession (March 2001 to November 2001) the stock market was already going down by the time the Fed started cutting rates, and continued going down.
In the Great Recession (December 2007 to June 2009) the stock market reaction to the Fed cutting rates was more optimistic, with a three-month approximately 10 percent rally in the S&P 500. After that, the stock market dropped more than 50 percent, with several “sucker rallies” () in between. Those rallies are common in recessions, including the early 2000s recession.
We want the debt that we do not need
Since there have been many previous recessions before the last two, some business commentators refer back to several of those other recessions to predict the future, and to frame Fed rate cuts in a positive light. Lower rates stimulate economic activity by making credit more easily and widely available, which could in theory prevent a recession.
The problem is that it is human nature to buy more than we can afford, or need, if we can fund those purchases through debt. Most people will want to buy a more expensive car on credit than they can afford either paying cash or with higher interest rates; the latter increase monthly payments. The same goes for homes.
This is all about perceived status, and extends to corporations. Other things being equal, a CEO of a larger and more dominant company will have a higher status among peer CEOs. As a result, companies tend to take on more debt, if it is easily available at low rates, to fund acquisitions or “buy” market share prior to recessions. Conservative use of funds goes out the window if credit is easily available.
As noted above, many business commentators refer back to recessions other than the last two to predict the future. The problem is that the farther back you go, the more different the socio-economic environments tend to be from today. This is why it is probably a good idea to look at what happened more recently when trying to extrapolate to now and the near future.
A Fed rate cut prior to a recession is not a good sign
Should a Fed rate cut at a period when the signs of an upcoming recession are pilling up be a source of concern for stock market investors? Any way you look at it, the answer is “yes”.
Human nature does not change that easily, and greed will not be checked unless things go really bad. When things go really bad, behavior changes. Individuals and organizations become more conservative regarding their finances.
Very likely a Fed rate cut prior to a recession will sustain or even exacerbate the types of behavior that are at the source of the recession.
Having said that, Fed rate cuts are important for the economic recovery and renewal that are normally seen after recessions.
