Will a Jumbo Interest Rate Cut Be Followed by a Recession? It’s Happened Before

When the Federal Reserve starts a rate cut cycle with a jumbo-sized slash in the past, it hasn’t always worked out well for the economy.

After holding its key interest rates at decades-high levels in a bid to bring down inflation, the Federal Reserve made its first rate cut in four years on Wednesday. While the Fed generally reduces the federal funds rate a quarter-of-a-percentage point at a time, the central bank was more aggressive this week, reducing rates by 50 basis points.

In some recent cases, super-sized rate cuts have come before a recession. The Fed, and some economists, think there are reasons that won’t happen this time.

Has This Happened In the Past?

This isn’t the first time the Fed has taken a bigger swing at rates to open a rate-cut cycle.

In 2001 and 2007, the Fed faced similar situations. After keeping interest rates elevated for an extended period, central bankers cut them quickly by 50 basis points (bp). In these cases, the sharp cuts to interest rates weren’t enough to stave off a recession.1

“On all the recent occasions when the Fed has accelerated up to 50bp cuts, bad things have then happened,” wrote a team of Deutsche Bank analysts led by research strategist Jim Reid this week.

But while the rate cuts didn’t avert an economic slowdown, the size of the cuts may not have been the problem, Deutsche Bank wrote in its note. “Correlation isn’t causation, and it’s hardly like the GFC (Great Financial Crisis) only happened because the Fed opened with 50 bps,” the note said.

Will It Happen This Time?

By most accounts, economists still predict that the Federal Reserve will achieve a soft landing, in which the economy slows enough to tame inflation but not so much that it tips into a recession.

“Recession alarm bells should sound a bit muted with an encouraging employment report, solid gains in retail sales, and a rebound in industrial production easing fears of an economy on the precipice of a downturn,” wrote Oxford Economics US Economist Matthew Martin on Wednesday.

Unlike in 2001 and 2007, the Federal Reserve is working offensively rather than defensively, Deutsche Bank said Friday. In both historical examples, economists said the Federal Reserve was cutting to try to stabilize an already volatile economy.

Today, central bankers are trying to navigate an economy that has been anything but usual in the wake of the pandemic.

“The 2024 cut reflects a more complex balancing act,” Deutsche Bank analysts wrote. “The Fed is navigating a post-pandemic world grappling with persistent inflation while trying to achieve a ‘soft landing’ for the economy.”