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The Fed should cut interest rates “sooner rather than later,” according to analysts at Allianz.
Analysts say that although the exact timing of the first rate cut may seem less important, it is actually vital to determining the overall impact of the rate cut cycle on the economy.
They note that many market participants are currently focused on whether the Fed, reassured by the latest inflation data, will begin its rate-cutting cycle in September or delay it further, as several Fed officials have suggested. However, analysts believe that this view underestimates the timing of the first cut.
“In the current circumstances, timing is crucial to determining the cumulative size of the cycle and the well-being of the economy,” analysts said in an article published by the Financial Times.
Typically, the timing of the first rate cut allows markets to price the entire cutting cycle with more confidence. However, this is less relevant today, given the Fed’s data-driven approach, which lacks strategic vision.
According to analysts, this approach deprived fixed income markets of clear guidance, leading to volatility in US Treasury yields. For example, in the four weeks leading up to the Fed’s latest policy meeting, two-year bond yields fluctuated significantly, while the 10-year yield showed similar volatility.
They argue that the timing of interest rate cuts is key to the state of the economy. There are increasing signs of economic weakness, including deteriorating forward-looking indicators and significant erosion in balance sheet margins held by small businesses and low-income households.
“The vulnerabilities, which are likely to increase as more late effects of the 2022-2023 supercycle emerge, come amid significant cyclical economic and political volatility, as well as shifts in areas such as technology, sustainable energy and trade supply chain management,” the analysts wrote.
Historically, timely interest rate cuts have contributed to better economic outcomes. Analysts cite the example of rapid interest rate cuts following the 3 percentage point rate hike cycle in 1994-1995, which helped achieve the so-called “soft landing.” Analysts say this historical precedent suggests that a timely rate cut could lead to a similarly positive outcome in the current economic landscape.
They warn that delaying the first rate cut increases the likelihood that the Fed will need to cut rates more aggressively later to reduce the risk of a recession. This scenario would mirror the Fed’s initial policy error in 2021-22 when it mischaracterized inflation as “temporary” and delayed its policy response, raising interest rates aggressively.
“If the Fed is forced this time into a significant cutting cycle due to the late start and accelerating economic and financial vulnerabilities, it will also have to end up cutting more than necessary based on longer-term conditions,” analysts say. .
“Rather than being a given, the final price of the next Fed rate cutting cycle depends on when it starts. They added that the longer central bankers wait to cut rates, the greater the risk that the economy will suffer unnecessary damage to its growth prospects and financial stability, particularly affecting sectors that are more Weakness.
In doing so, the Fed will once again find itself reacting to crises rather than proactively steering the economy toward the soft landing that many hope for.
