Is There Too Much Focus on Fed’s Moves?

Summary

Podcast Summary: Thoughts on the Market – "Is There Too Much Focus on Fed’s Moves?"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: Is There Too Much Focus on Fed’s Moves?
• Release Date: March 6, 2025

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Introduction and Context

In the episode titled "Is There Too Much Focus on Fed’s Moves?", Andrew Sheets, the Head of Corporate Credit Research at Morgan Stanley, delves into the prevailing emphasis on the Federal Reserve’s (Fed) interest rate decisions. Airing on March 6, 2025, Sheets challenges the market's intense focus on potential Fed rate cuts, arguing that other economic factors may wield more significant influence on market performance.

Morgan Stanley's Perspective on Fed Rate Cuts

Andrew Sheets initiates the discussion by questioning the significance that investors place on the number of Fed rate cuts within the year.

"[00:00]"
"Today I'm going to talk about why the number of Fed rate cuts this year may matter less than you think."

Sheets emphasizes that while the Fed's role in combating inflation and setting interest rates is undeniably crucial, the central bank's policy adjustments might not be the primary driver of market dynamics as commonly perceived.

The Importance of Economic Stability

A core argument presented by Sheets revolves around the value of stability in Fed policies. Morgan Stanley's economists anticipate that factors such as U.S. tariff and immigration policies will compel the Fed to maintain higher interest rates for an extended period compared to earlier in the year.

"[00:10]"
"Given the choice, investors should be rooting for less change, not more to start."

Sheets contends that excessive focus on frequent rate changes can overshadow the underlying economic stability that a consistent Fed policy fosters. He posits that a stable Fed funds rate suggests a balanced economic equilibrium, avoiding extremes of high inflation or insufficient growth.

"[00:50]"
"Stability is good. A stable Fed funds rate almost by definition implies a stable equilibrium that doesn't involve overly high inflation pushing rates further up, or overly weak growth pushing them further down."

Historical Perspective on Rate Changes and Market Impact

Delving into historical data, Sheets illustrates how significant fluctuations in the Fed's target rate have historically correlated with adverse market performances. He highlights that:

• Large rate declines often coincide with unexpected economic slowdowns, leading to market instability.
• Historically good economic growth periods, like the mid-1990s, were characterized by minimal rate reductions and prolonged periods of elevated rates.

"[01:30]"
"Some of the market's worst losses have coincided with the largest declines in the Fed's target rate, because those large rate cuts usually occur only when there is a large unexpected slowing in the economy, something markets often don't like."

This historical lens supports Morgan Stanley's stance that minimal and predictable rate changes are preferable for maintaining market confidence and reducing volatility.

The Role of Tariffs and Immigration Policy

Sheets underscores that beyond Fed policies, U.S. tariff and immigration policies are pivotal economic factors that could influence overall economic growth and inflation. These policies might necessitate the Fed to sustain higher rates longer than initially anticipated.

"[02:10]"
"The question of whether the Fed will cut once, which is the Morgan Stanley base case, twice, or not at all in 2025 may not matter all that much, at least for credit."

He suggests that these external policies have a more profound impact on economic health than the number of Fed rate adjustments, thereby shifting the focus away from the Fed’s movements.

Implications for Investors

For investors, Sheets advises that the key consideration should not solely be the Fed’s rate decisions but the broader economic indicators that influence these decisions. He emphasizes that:

• Economic performance: The actual performance of the economy and factors like growth and inflation are more critical than the Fed’s rate tweaks.
• Potential policy shifts: Significant changes in tariffs or immigration could lead to unexpected Fed responses, introducing uncertainty.

"[02:45]"
"Those big changes which could drive big changes in Fed policy responses, are the scenario that worries us."

Thus, investors should prioritize understanding the underlying economic conditions and policy changes over anticipating the number of Fed rate cuts.

Conclusions and Key Takeaways

Andrew Sheets concludes by reiterating the importance of not overemphasizing the Fed’s rate movements in isolation. He asserts that:

• Stability in Fed policies contributes to a predictable economic environment, which is beneficial for market participants.
• External economic policies such as tariffs and immigration reforms are more influential in determining economic trajectories and, by extension, Fed actions.
• Investors should focus on the broader economic landscape rather than fixating solely on the Fed's rate cut projections.

Sheets’ analysis prompts investors to adopt a more holistic view of the economic factors at play, advocating for a balanced perspective that considers both Fed policies and other significant economic drivers.

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Please Note: The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for your needs.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Today I'm going to talk about why the number of Fed rate cuts this year may matter less than you think. It's Wednesday, March 5th at 2pm in London. Financial markets spend a lot of time discussing the Federal Reserve, and for good reason. The central bank of the world's largest economy plays a central role in fighting inflation and setting interest rates. And what they'll do this year is topical and shifting. At Morgan Stanley, our economists think that US Tariff and immigration policy will lead the Fed to keep rates somewhat higher for somewhat longer than they did at the start of the year. Yet we think there may be just a little bit too much focus on just how much the Fed changes policy over the course of the year. Indeed, we'd go as far to say that given the choice, investors should be rooting for less change, not more to start. For all that has happened in the world since the end of October of 2024, expectations for the Fed's interest rate path have been remarkably stable. The US two year treasury, which is a decent proxy of where the Fed's rate will average over the next 24 months, has hovered in a very narrow range. It simply hasn't been telling us very much. Other factors have been moving markets. There's also a pretty reasonable rule of thumb from history. Stability is good. A stable Fed funds rate almost by definition implies a stable equilibrium that doesn't involve overly high inflation pushing rates further up, or overly weak growth pushing them further down. The best growth in recent history in the mid-90s, occurred after the Fed reduced interest rates less than 1% and then kept them stable at a pretty elevated rate for a pretty extended period of time. Large changes in rates, on the other hand, in either direction, are a different story. Some of the market's worst losses have coincided with the largest declines in the Fed's target rate, because those large rate cuts usually occur only when there is a large unexpected slowing in the economy, something markets often don't like. Meanwhile, we think the Fed also very much wants to avoid a scenario where it has to start raising rates again. Given the potential confusion that this could signal after it only recently continued to lower them. And so if over the course of this year the Fed does need to raise interest rates, given the very high bar we think they've given themselves for action, it probably suggests that something unexpected and not in a necessarily good way has occurred. Central bank policy will always matter for markets, but for investors, the question of whether the Fed will cut once, which is the Morgan Stanley base case, twice, or not at all in 2025 may not matter all that much, at least for credit. Far more important is the performance of the economy and whether big changes to tariffs or immigration policy drive big changes to growth and inflation. Those big changes which could drive big changes in Fed policy responses, are the scenario that worries us. Thanks for listening. If you enjoy the show, leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

[B]

The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for.