ATFX official website - A historical law that cannot be ignored! The Federal Reserve may have to wait longer before cutting interest rates

With peak interest rates in sight, markets expect the Federal Reserve and other central banks to exit the rate hike cycle and begin the countdown to rate cuts.

History shows that the average time interval between the last Fed rate hike and the first rate cut is short, but it has become longer since the 1990sAs a new global easing cycle approaches, investors should bear this in mind

One thing is certain - the Fed is doing its best to dampen market expectations of a rapid "pivot" to prevent loose financial conditions from undermining the anti-inflation efforts of the past 18 months.

If the Fed's expected 25 basis points rate hike in September proves to be the last, the fully priced first rate cut will wait until May next year, eight months apart, significantly longer than the average time between the last hike and the first cut decades ago.

Richard de Chazal, an analyst at William Blair, a research firm, found that once interest rates peaked since 1971, the Fed has kept them there for an average of only 5.5 months before cutting them again. "In the past, markets have tended to underestimate the extent of rate hikes and rate cuts," Mr. De Chazal said. "This time, the average five-month gap between the last rate hike and the first rate cut will be a bit short, but nine to 12 months doesn't seem so unusual."

Joe Lavorgna, chief US economist at SMBC Nikko Securities America, points out that if you look back at the 18 policy cycles since the 1950s, the average time between the last rate hike and the first rate cut is shorter, at three months. But the average time between the last five cycles is 7.6 months, more than double the former.

Similarly, historical data on the Bank of England's 11 policy changes over the past 50 years show an average interval of six months between its last rate rise and its first. However, in the four cycles since the BoE gained independent policy-making authority in 1997, this interval has been extended to 8.75 months.

Why is the time interval longer?

Nobel laureate economist Milton Friedman famously argued about the link between changes in monetary policy and economic conditions that the lag period between monetary policy decisions and their impact on the economy is becoming longer, if not more variable.

There are several explanations for this.

After high and volatile inflation in the 1970s and early 1980s forced central banks to adjust policy quickly, macroeconomic volatility steadily declined sharply during the "Great Moderation" between the mid-1980s and the 2007 financial crisis.

Better and faster access to information means that policymakers can now make more informed decisions. In theory, central bankers should be more proactive, not reactive, and able to make slightly longer-term policies.

Moreover, inflation targeting, more sophisticated financial marekting, more transparent central bank communication and greater autonomy have all played a role since the 1990s.

Meanwhile, the global easing cycle appears to be tentatively underway. Brazil's central bank was one of the first to raise interest rates in early 2021, and began cutting them after a 12-month pause. The central bank last eased in 2015-16, when there was a 15-month gap between the last rate hike. Both are much longer than any period since the country launched its real programme in the mid-1990s.

The Reserve Bank of Australia has paused interest rate hikes at two policy meetings, but appears far from turning. Current market pricing suggests this will not happen until 2025, which will be a longer interval.