In the past 35 years, the five interest rate reduction cycles of the Federal Reserve

According to a recent speech by Federal Reserve Chairman Powell, a new round of interest rate cuts is about to begin. To explore the impact of interest rate cuts on the economy and the market, we reviewed the 5 interest rate cut cycles that the United States has experienced over the past 35 years. Looking back at past interest rate cut cycles, we can see that each rate cut has its specific economic background and reasons.

For example, from 1990 to 1992, the U.S. economy fell into recession due to the savings and loan crisis and the Gulf War, with credit tightening and economic slowdown. The Federal Reserve stimulated recovery through consecutive interest rate cuts. The interest rate cuts from 1995 to 1998 were to address declining inflation and economic slowdown, as well as to deal with the global market turmoil caused by the Asian financial crisis and the Russian debt crisis. In the 21st century, the interest rate cuts from 2001 to 2003 were to address the economic recession following the bursting of the internet bubble, to prevent further economic deterioration. In 2007-2008, the global financial crisis erupted, and the Federal Reserve took significant interest rate cuts and unconventional monetary policies to stabilize the market and promote recovery. Finally, the interest rate cuts from 2019 to 2020 were to address the economic slowdown caused by the COVID-19 pandemic, with the Federal Reserve quickly implementing aggressive interest rate measures to support the economy and employment.

01 1990-1992 Interest Rate Cut Cycle, Easing Pressure from the Savings and Loan Crisis and Recession

The Federal Reserve continued to cut interest rates from July 1990 to September 1992. The federal funds rate dropped from 8% to 3%.

In 1990, the Federal Reserve noticed the economy slowing down and the financial markets becoming unstable, so it gradually shifted to a more accommodative policy. In July, as the economic growth slowed and bank loans tightened, despite rising food and fuel prices leading to some inflation, the committee decided to implement interest rate cuts. In August, Iraq's invasion of Kuwait led to a surge in oil prices, causing the economy to slump and financial markets to become volatile.

In June 1990, the oil price was $41.33. With the outbreak of the Gulf War, oil prices soared all the way to $93.64 by September, more than double the price three months ago. This put tremendous pressure on the U.S. economy. The U.S. GDP growth rate dropped from 1.89% in 1990 to -0.11% in 1991. Meanwhile, the unemployment rate rose from 5.6% in 1990 to 7.5% in 1992.

By October, the economy had significantly weakened, and the committee decided to further loosen its policy. At the same time, the government reached a budget agreement to reduce the deficit, which also prompted the Federal Reserve to take accommodative measures. By the end of 1990, the economic conditions deteriorated further, the pressure on the financial system increased, and inflation pressures eased.

Then-Federal Reserve Chairman Alan Greenspan stated at a congressional hearing in early 1991: "Although the economy is declining, the current situation indicates that this recession may be shorter than previous post-war recessions. One important reason is that the surge in oil prices caused by the Gulf War has been reversed." Another reason is that in the past year and a half, especially in recent months, interest rates have dropped significantly, which should help alleviate the negative impact of the Gulf crisis and credit tightening on the economy.

After the Fed cut interest rates, the stimulating effect on the economy is very obvious. The US CPI rose from 121.1 points in 1989 (pre-war) to 141.9 points in 1993 (post-war). In 1989, the year-on-year CPI growth rate relative to 1988 was 4.48%. In 1993, the year-on-year CPI growth rate relative to 1992 was 2.75%. The US GDP growth rate rebounded from -0.11% in 1991 to 3.52% in 1993.

At the same time, interest rate cuts have a significant stimulating effect on the short-term performance of the market.

The table below shows the main market returns calculated from the start of the interest rate cut cycle from "1990-1992".

02 1995-1998 Interest Rate Cut Cycle, Preventing Economic Recession and Financial Risk Management

The Fed continued to cut interest rates from July 1995 to January 1996. This was a relatively small rate cut, with the federal funds rate dropping from 5.75% to 5.25%.

In order to control inflation, the Fed implemented a tightening cycle in 1994-1995 and successfully achieved an "soft landing" for the economy. However, the market began to worry that the economy might slip into a recession. In order to prevent further economic slowdown, the Fed chose to cut interest rates in 1995 and 1996, aiming to stimulate economic activity through loose monetary policy and avoid potential recession In its statement in 1996, the Federal Reserve stated: "The recent economic expansion slowdown has reduced future potential inflationary pressures. Due to the restraint on price and cost trends, the slight easing of monetary policy is consistent with the goals of controlling inflation and sustainable growth."

Following this rate cut, the U.S. economy continued to recover. The GDP growth rate increased from 2.68% in 1995 to 3.77% in 1996, and further rose to 4.45% in 1997.

In July 1997, the Asian financial crisis erupted. The Thai baht was severely attacked by speculation, forcing Thailand to abandon its fixed exchange rate and switch to a floating exchange rate. The sharp devaluation of the Thai baht led to a currency and financial crisis across the entire Asian region. This crisis quickly spread to various Southeast Asian countries, causing currency devaluations, stock market crashes, and putting immense pressure on the banking system and businesses. Global markets were plunged into panic, and financial market volatility intensified as a result.

From September to November 1998, the Federal Reserve cut interest rates continuously, reducing the federal funds rate from 5.50% to 4.75%. The key reasons for the Fed's rate cuts at that time were threefold: 1) Preventing economic slowdown: Despite strong U.S. economic performance, the Fed was concerned that global economic instability could drag down the U.S. economy. By cutting rates, the Fed hoped to prevent potential economic slowdown and ensure continued economic expansion. 2) Stabilizing financial markets: In 1998, international financial market uncertainties led to volatility in the U.S. stock and bond markets, especially exacerbated by the crisis of Long-Term Capital Management (LTCM), which heightened market panic. The Fed increased liquidity through rate cuts to help stabilize financial markets and prevent a larger-scale financial crisis.

The rate cuts had four main effects:

1. Lowering borrowing costs, making it easier for financial institutions to obtain funds, easing the tension in financial markets, especially after the LTCM incident when the market became more risk-averse.

2. Instilling confidence in the market, the Fed's rate cuts signaled its ability and willingness to take action to stabilize the financial system, which was crucial for restoring confidence among investors and financial institutions.

3. Against the backdrop of the spread of the Russian financial crisis, the Fed's rate cuts provided support for the global economy, reducing the spread of the crisis.

4. The Fed injected additional growth momentum into the economy, helping to resist the risk of recession.

In 1998, the U.S. real GDP growth rate was 4.5%, remaining strong in a globally uncertain environment. After the rate cuts, the U.S. CPI index steadily rose from 161.6 points in 1998 to 168.3 points in 1999. The year-on-year growth rate in 1998 compared to 1997 was 1.55%, while in 1999 compared to 1998, it was 2.68%.

The market performance after the rate cuts was excellent The table below shows the main market returns calculated from the starting point of the first interest rate cut during the "1995-1998" rate cut cycle.

03 2001-2003 Rate Cut Cycle, Responding to the Burst of the Internet Bubble and the Recession Caused by 9/11

During 2001-2003, the U.S. economy faced multiple challenges such as the bursting of the internet bubble, the 9/11 terrorist attacks, and subsequent economic recession. To address these shocks, the Federal Reserve significantly cut interest rates and implemented a series of loose monetary policies aimed at stimulating economic growth and stabilizing financial markets. The 9/11 attacks had a significant impact on the economy, leading to severe market volatility and a sharp decline in confidence. The Federal Reserve quickly took action to stabilize the market by further cutting interest rates and injecting liquidity.

Although these measures helped alleviate the most severe economic shocks, the recovery process in 2002 was still slow, with weak corporate investment, low consumer confidence, and rising unemployment rates. By 2003, with continued loose monetary policy, economic activity gradually picked up, consumer spending increased, and signs of recovery in the housing market emerged. However, inflation pressures remained low, and there was still a risk of deflation in the economy. Overall, while the Federal Reserve's policies effectively prevented the economy from further deteriorating, the recovery process remained challenging.

In 2001, the market witnessed the bursting of the internet bubble. During this period, the stock market crash spread to the real economy, leading to a mild contraction in GDP, rising unemployment rates, and an eight-month economic recession. The subsequent 9/11 terrorist attacks further exacerbated the economic issues.

In January 2001, the Federal Reserve began a significant interest rate cut cycle to address the economic slowdown following the bursting of the internet bubble and its subsequent impacts. In a statement, the Federal Reserve said, "Due to low inflation expectations, the committee judges that a slightly expansionary monetary policy will provide further support to the economy, with the expectation that the economy will improve over time." During this period, the federal funds rate dropped from 6.50% to 1.75% in December 2001, and further decreased to 1% in June 2003, with a total rate cut of 500 basis points. These series of rate cuts aimed to stimulate economic growth by reducing borrowing costs and help the U.S. economy recover from recession.

After the rate cuts, the U.S. GDP growth rate showed signs of improvement. In 2002, the real GDP growth rate in the U.S. was 1.7%, showing a relatively weak performance. However, by 2004, as the effects of the rate cuts gradually manifested, the GDP growth rate rose to 2.9%. Subsequently, in a low-interest rate environment, the U.S. economy further recovered, with a GDP growth rate of 3.85% in 2004.

The table below shows the major market returns calculated from the start of the rate cut cycle from 2001 to 2003.

04 2007-2008 Rate Cut Cycle, Responding to the Subprime Mortgage Crisis and the Global Financial Crisis

In 2007-2008, the global financial crisis erupted, causing profound impacts on the U.S. economy. The main reasons for the crisis included the collapse of the real estate market, credit market freeze, and the fragility of the financial markets.

Prior to this, the U.S. real estate market had been thriving for a long time, but after the subprime mortgage issues were exposed, housing prices fell, leading to a situation where many borrowers were unable to repay their loans, triggering the subprime mortgage crisis. Financial institutions suffered severe damage due to holding high-risk loans, leading to a credit market contraction and liquidity drying up. To address the crisis, the Federal Reserve rapidly reduced rates from 5.25% in September 2007 to 0-0.25% by the end of 2008 to increase market liquidity. In March 2008, the Federal Reserve supported JPMorgan's acquisition of the near-bankrupt Bear Stearns, avoiding further collapse of the financial system.

However, the market turmoil did not stop, with Lehman Brothers filing for bankruptcy in September 2008, plunging the global financial markets into panic. Despite massive rescue measures taken by the Federal Reserve and the government, the economy contracted significantly, and the unemployment rate rose to over 10%. This "Great Recession" demonstrated the complexity of the global financial system and the challenges of responding to it.

The deterioration of the economic situation has had a serious impact on the labor market. During the period from 2007 to 2008, the rapid rise in the unemployment rate in the United States, especially in the second half of 2008 when the financial crisis intensified, led to a sharp increase in the unemployment rate.

At the same time, the economic recession also led to significant deflation risks.

Therefore, in September 2007, the Federal Reserve began a cycle of significant interest rate cuts aimed at addressing the financial market turmoil and economic recession risks caused by the subprime mortgage crisis. During this period, the federal funds rate gradually decreased from 4.75% to 0.25% in December 2008, with a total rate cut of 450 basis points. The purpose of these rate cuts was to stimulate economic activity, stabilize the financial markets, and mitigate the negative impact of the crisis on the economy by reducing borrowing costs.

The Federal Open Market Committee (FOMC) statement on September 18, 2007, stated: "The Committee believes that the tightening of credit conditions may intensify the adjustment in the housing market and restrain economic growth more broadly. The actions taken today are aimed at preventing adverse effects on the overall economy from the financial market turmoil and promoting moderate growth."

In this statement, the Federal Reserve mentioned that the tightening of credit conditions could intensify the adjustment in the real estate market and restrain overall economic growth. The rate cut on that day was intended to help prevent the negative impact of financial market turmoil on the broader economy and promote moderate economic growth.

Despite the gradual interest rate cuts by the Federal Reserve starting in September 2007, the U.S. GDP growth rate fell to 1.9% in 2007. With the full outbreak of the financial crisis, the GDP growth rate further declined to -0.1% in 2008, indicating a severe contraction in economic activity. In 2009, the GDP growth rate further dropped to -2.5%. However, the loose monetary policy laid the foundation for economic recovery, and from 2010 onwards, the U.S. GDP growth rate gradually recovered.

The table below shows the main market returns calculated from the point of the first interest rate cut during the "2007-2008" rate cut cycle.

05 2019-2020 Interest Rate Cut Cycle, Preemptive Rate Cuts, and Response to Liquidity Crisis

The Federal Reserve launched an interest rate cut cycle in August 2019. Initially, the Fed's goal was to address the challenges posed by the global economic slowdown and trade uncertainty.

However, with the outbreak of the COVID-19 pandemic in early 2020, the global economy quickly plunged into crisis. The spread of the pandemic led to massive economic lockdowns and shutdowns, disruptions in the global supply chain, sharp declines in consumer demand, soaring unemployment rates, and a significant weakening of economic activities. The impact of the pandemic on the economy made financial markets extremely fragile, leading to severe volatility in the financial markets.

As a result, the Federal Reserve cut interest rates to support the government's massive fiscal stimulus measures and significantly expanded its balance sheet. During this cycle, the federal funds rate gradually decreased from 2.25% to 0.25% in March 2020.

Subsequently, as the pandemic situation gradually improved, the economy began to recover in the second half of the year.

Although the Federal Reserve conducted several interest rate cuts in 2019, the overall performance of the U.S. economy remained stable, with a GDP growth rate of 2.3%, slightly lower than the growth rates of previous years. With the spread of the pandemic and the implementation of lockdown measures, the U.S. economy suffered a severe blow. In 2020, the GDP experienced a historic contraction, with a growth rate of -3.4%, marking the most severe economic contraction since the 2008 financial crisis. In 2021, supported by a loose monetary environment, the U.S. economy quickly rebounded, with a GDP growth rate reaching 5.7%.

The table below shows the main market returns calculated from the start of the first interest rate cut during the "2019-2020" interest rate cut cycle.

Summary 06

During each interest rate cut cycle, the issues addressed by the Federal Reserve are different. From 1990 to 1992, in response to economic slowdown and instability caused by the Gulf War, the Federal Reserve cut interest rates to ease financial stress and promote economic recovery. From 1995 to 1998, facing potential recession and the Asian financial crisis, the Federal Reserve once again stimulated the economy and stabilized the market through interest rate cuts. From 2001 to 2003, the bursting of the dot-com bubble and the 9/11 attacks led to an economic recession, and the Federal Reserve significantly cut interest rates to help the economy recover. During the global financial crisis of 2007-2008, the Federal Reserve lowered interest rates to near zero to address the subprime crisis and economic recession. Most recently, in 2019-2020, the outbreak of the COVID-19 pandemic led the Federal Reserve to quickly cut interest rates to support economic activity.

Comparatively, the Federal Reserve's current interest rate cut is more akin to a preventive cut, similar to the early stages of the cuts in 1990-1992 and 1995-1998. We will further analyze the characteristics and details of these two different interest rate cuts.

Authors: Zhang Xiaojun S1680623100003, Zhang Kaisong, Li Peiyu; Source: Huaxing Securities Institutional Services; Original Title: "New Perspectives | Federal Reserve Series - Interest Rate Cycles in the United States over the Past 35 Years"