Don't count on the Federal Reserve! Emergency rate cuts are unlikely

Global stock markets plummeted again on Monday, with people beginning to question whether the US economy is heading into a recession due to unexpectedly weak job reports released last Friday. Investors are increasingly hoping that this will prompt Federal Reserve officials to take emergency rate-cutting measures.

However, this is highly unlikely to happen.

Chicago Fed President Charles Evans stated in an interview with The New York Times on Monday, "The Fed's job is not to ensure the comfort of the stock market."

In hindsight, there are compelling reasons to believe that the Fed should have cut rates at the meeting last week, which concluded before the disappointing job report was released.

If officials had known that the unemployment rate would jump from 4.1% in June to 4.3% in July, nearly a full percentage point higher than earlier this year, perhaps they would have been more convinced that the US economy is weakening and that the benefits of cutting rates outweigh the risks.

However, holding an emergency meeting to lower rates before the next scheduled Fed meeting in over six weeks could backfire and exacerbate panic.

Rare Occurrence of Emergency Rate Cuts

The Federal Reserve's Federal Open Market Committee meets eight times a year to vote on where they believe interest rates should be set to promote maximum employment and stable prices.

However, if something happens between these meetings that changes their view on the ideal rate level, officials can convene an unplanned "emergency" meeting. The last time they did this was at the onset of the pandemic, when they voted to cut rates by 50 basis points. Then, less than two weeks later, they met again and cut rates by a full percentage point, bringing them close to zero.

At that time, signs that things were about to get bad were already clear. By taking two large emergency rate cuts in quick succession, Fed officials did not have to weigh whether their actions would unnecessarily cause panic among Americans.

Prior to these rate cuts, the last time the Fed was forced to make an emergency rate cut was during the Great Recession in the fall of 2008 following the collapse of Lehman Brothers.

Emergency Rate Cuts Could Exacerbate Panic

The last thing the Fed wants is for people to believe that the US economy is on the brink of a potential recession. This concern, whether true or not, is likely to quickly become a self-fulfilling prophecy.

Former Philadelphia Fed President Charles Plosser stated at an emergency meeting on October 7, 2008, "Overall, I don't like cutting rates between scheduled meetings. I think it's a signal of panic, not stability." However, he reluctantly accepted the emergency rate cut due to actions taken by other central banks.

But the current situation is different.

Central banks that have recently cut rates, including the Bank of Canada, the European Central Bank, and the Bank of England, have done so at scheduled meetings.

If the Fed decides to take emergency rate-cutting measures, people will inevitably wonder: What does the central bank of the world's largest economy know that others do not?

This was the sentiment expressed by then-San Francisco Fed President Janet Yellen at an emergency meeting held on January 9, 2008 The minutes of the Federal Reserve meeting at the time showed that the current Treasury Secretary Yellen said, "I am concerned that this may be seen as a signal of committee panic and may, to some extent, incorrectly reflect that the internal information we have shows a worse situation than the market currently believes."

She also worried that an emergency rate cut might be seen as an overreaction to the employment report. Here, it refers to the employment report released in December 2007, which showed a 0.3% increase in the U.S. unemployment rate, reaching 5%.

In the end, officials waited until another unplanned meeting several weeks later to cut rates.

Emergency rate cuts do not take effect immediately

At the October 2008 meeting, Prosser warned that an immediate rate cut would not make the overall economic pain less in the coming months.

The current situation is similar.

To some extent, Federal Reserve officials deciding when and how much to cut rates will not have an immediate impact, as any interest rate adjustment takes about a year to have an impact on the entire economy.

U.S. Treasury yields have already plummeted in anticipation of rate cuts. As they are seen as a benchmark for various loan rates paid by Americans, this decline may help alleviate the financial burden faced by current borrowers