If the U.S. Federal Open Market Committee (FOMC) cuts its key policy rate on July 31, 2019, as is widely expected by market participants, it could mark the start of an unusual rate cutting cycle. In at least the last four decades, the Fed has never started a rate cutting cycle with market and economic conditions — as proxied by the U.S. unemployment rate, stock prices, high yield bond spreads, Treasury yields and the real Fed Funds Rate — as easy and accommodative as they are today.
While the knee-jerk reaction of capital markets to rate cuts is typically positive, the persistently low level of interest rates around the world for most of the last decade is starting to create major imbalances. As Morgan Stanley strategist Ruchir Sharma writes in an op-ed in today's New York Times, "by further lifting stock and bond prices and encouraging people to take on more debt, lowering rates could set the stage for the kind of debt-fueled market collapse that has preceded the economic downturns of recent decade. Our economy is hooked on easy money — and it is a dangerous addiction." We agree.
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