"Saving Ammunition" Is Not A Reason To Avoid Rate Cuts - Hedge Fund Alpha (formerly ValueWalk Premium)
Rate Cuts

“Saving Ammunition” Is Not A Reason To Avoid Rate Cuts

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Q3 2019 hedge fund letters, conferences and more

It isn’t just how much the Fed cuts rates that matters; it is how soon they do it.

You don’t have to go far to hear calls for the Federal Reserve to not cut rates because they need to, “save ammunition” for when things are really bad. This imagines that the rate cut itself is the countervailing force against economic weakness.

But it doesn’t work that way.

Outside of a questionable psychological effect, the change in rate isn’t important, it is the level of the rate and for how long it persists. In fact, the Fed’s stimulative effect is more potent the sooner it is used, because lowering interest rates sooner will cost borrowers less than lowering them later.

In order to illustrate this, consider two scenarios. In the first scenario, “fire the ammunition,” the Fed cuts 0.25% at each of the next seven meetings to get down to the prior Fed low – a range of 0-0.25%. In the second scenario, “save the ammunition,” the Fed doesn’t cut rates again until March of next year and subsequently lowers 50 basis points three times, then 25 basis points once.

In both scenarios, the Fed has lowered to 0.125% by July of next year. These scenarios shouldn’t be construed as predictions, but rather were arranged to illustrate the concept. See the chart below for a graphical representation. For simplicity, I considered the Fed Funds target rate to be the mid-point of the target range.

Rate Cuts

Read the full article here by Eric Hickman, Advisor Perspectives

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