Here’s why an emergency rate cut would be a bad idea
Following a disappointing jobs report, the stock market plummeted on Monday, with the Dow dropping more than 1,000 points.
The Dow slid 2.6%, the S&P 500 was down 3%, and the Nasdaq declined 3.4%.
In July, the economy added 114,000 jobs, which was lower than expected, according to jobs report data released on Friday. The unemployment rate also rose, inching up from 4.1% in June to 4.3%.
Some traders and finance experts are now predicting or calling for an emergency rate cut in response to the market’s volatility and the weak jobs report. Low interest rates can help spur the economy since it becomes cheaper to borrow money.
But Marketplace spoke to economists who say an emergency rate cut would be a bad idea. As we always say here: The stock market is not the economy.
“The Federal Reserve’s mandate is to think about the economy and not necessarily what’s happening in financial markets,” said Tyler Schipper, an associate professor of economics at University of St. Thomas. “When the stock market has a really bad day, that doesn’t necessarily change the Federal Reserve’s decision making.”
The Fed had a chance to cut rates at its regularly scheduled meeting last week, but opted not to because it wants to be more certain that inflation is moving toward the Fed’s 2% inflation target. Fed Chair Jerome Powell said there could be a rate cut this September.
Economic data has not changed substantially since the Fed made that decision, Schipper said.
If the Fed had that jobs report data, that possibly strengthens the case that they should have cut rates at its meeting, Schipper said. But Schipper said he doesn’t think that’s a strong enough reason to cut rates between meetings.
“I think markets might be slightly overreacting to that data without the bigger context. And the bigger context is, yes, the labor market has been slowing. But in 2024, we still, on average, have been creating more jobs than we were pre-pandemic in 2019,” Schipper said.
We’ve become accustomed to economists underestimating jobs numbers, but they overestimated them this time, which “freaked out” the markets, Schipper said.
People also shouldn’t forget that there have been enormous stock market returns over the past couple of years, said Tarek Hassan, an economics professor at Boston University. He views the day’s losses as more of a correction.
What is a bit worrying is that the Cboe Volatility Index, or the VIX, is a bit high, Hassan said. The index, also known as the “fear gauge,” measures market expectations of volatility and it rose to its highest level since 2020.
“But it’s not off the charts,” he said.
Hassan also said he thinks the Fed should make a rate cut soon and that the central bank should send more signals there will be one. But he doesn’t think they need to rush it.
The Fed rarely issues emergency rate cuts, last doing so back in March 2020 when the COVID-19 pandemic began. The only other emergency rate cuts that the Fed has issued this century happened in response to the 2007-08 financial crisis, the dot-com bubble bust and the 9/11 terrorist attacks.
“The case for making emergency rate cuts is typically to address real structural problems with the economy,” Schipper said.
During the Great Recession, the Federal Reserve and other central banks coordinated emergency rate cuts to help the global economy amid the housing crisis, Schipper said.
“That seems to be a very different case than the market dropping in response to below-expected job market numbers,” Schipper said.
Data has been wonky during the pandemic, and Schipper said our typical recession indicators haven’t been reliable lately. For example, the yield curve has been inverted for a while now. An inverted yield curve means that the interest paid by 10-year Treasury bonds is lower than shorter-term debt. Typically, that’s the sign of an impending recession, but we have yet to enter one.
If the Fed did an emergency rate cut, that could then give credence to the idea that the Fed is seeing signs of a crisis that we weren’t aware of, Schipper added.
“The Federal Reserve needs to be an institution that is calm and competent,” he said.
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