Historically, how have interest rate cuts ended when the economy achieved a soft landing?
Goldman Sachs found that G10 central banks tend to end the easing cycle slowly and cautiously by pausing interest rate cuts, with nearly half of the historically "soft landing" rate-cutting cycles lasting over a year. The institution believes that the Federal Reserve's statements in December align with the pattern of slowing down in the later stages of rate-cutting cycles historically
After multiple rounds of interest rate hikes in major global economies, 2024 has ushered in a rate-cutting cycle.
However, as monetary policy gradually loosens, market focus is shifting to a key question: When and how will these rate-cutting cycles end?
On the 22nd, a team of analysts led by Jan Hatzius at Goldman Sachs released a research report, summarizing three major patterns by analyzing the historical ways in which "soft landing" monetary easing cycles in G10 economies have ended:
Central banks tend to end easing cycles slowly and cautiously (usually pausing rate cuts); rising unemployment or policy rates above neutral rates prompt central banks to continue cutting rates; and central banks tend to lower policy rates below neutral rates.
The report suggests that these historical patterns support the current dovish expectations for interest rates in G10 countries, such as the Federal Reserve and Canada, which may continue to cut rates. Goldman Sachs also predicts that the Federal Reserve will further cut rates three times in 2025, each by 25 basis points.
Rate-Cutting Pace: Fast Initially, Then Slow, Cautious Adjustments
Goldman Sachs' analysis indicates that historically, when G10 countries enter the "soft landing" phase, central banks typically adopt a "front-loaded easing" policy approach.
In the first six months of a rate-cutting cycle, central banks often advance rate cuts at a faster pace, completing about 50% of the total rate cut. However, in the later stages, the pace of cuts significantly slows down. Data shows that in the three months before and after the start of a rate-cutting cycle, the average rate cut decreases from 1.1 percentage points to 0.7 percentage points.
Additionally, pausing rate cuts is a common phenomenon in historical rate-cutting cycles. In over 70% of rate-cutting cycles, there has been at least one pause, and nearly 50% of cycles have seen two or more pauses. This indicates that central banks tend to be cautious in the later stages of a rate-cutting cycle, gradually adjusting policies to approach target rates.
This pattern also determines the overall duration of the rate-cutting cycle: nearly half of the "soft landing" rate-cutting cycles last more than a year, indicating that rate cuts will not end quickly but will be completed in a more nuanced manner.
Key Factors: The Impact of Unemployment Rate and Neutral Rate
In determining when the rate-cutting cycle will end, Goldman Sachs identified two key variables: the unemployment rate and the level of policy rates relative to neutral rates.
First, if the unemployment rate rises after the start of a rate-cutting cycle, the probability of continued rate cuts significantly increases. Goldman Sachs' regression analysis shows that for every 1 percentage point increase in the unemployment rate, the likelihood of continuing rate cuts rises by 40 percentage points. This reflects the central bank's high sensitivity to the employment market, with changes in the unemployment rate seen as a priority consideration for monetary policy adjustments.
Second, the level of policy rates is also an important influencing factor. If the current policy rate is above the central bank's neutral rate estimate, the rate-cutting cycle typically continues. This phenomenon is particularly evident in the early stages of economic recovery, with Goldman Sachs estimating that for every 1 percentage point above the neutral rate, the likelihood of rate cuts increases by 25 percentage points.
Ending Pattern: Ending Easing Below Neutral Rate
Historical data shows that the rate-cutting cycles in G10 countries typically end when policy rates are below neutral levels. On average, the endpoint of the rate-cutting cycle is 1 percentage point lower than the neutral rate, and the data distribution shows a downward bias This means that when the economy approaches a "soft landing," the central bank tends to adopt a more accommodative monetary policy.
In addition, the rise in unemployment is a major driving factor for policy overshooting at the end of a rate-cutting cycle. Goldman Sachs' analysis indicates that every time the unemployment rate rises by 1 percentage point, the probability of the central bank lowering the policy interest rate below neutral increases by 20 percentage points. In contrast, the impact of core inflation and GDP growth on the continuation of rate cuts is relatively limited.
Outlook: The Federal Reserve's stance aligns with the historical pattern of slowing in the later stages of rate-cutting cycles
Based on these historical patterns, Goldman Sachs holds a dovish expectation for the monetary policy direction of major economies in the future. The report points out that the unemployment rates in countries such as the United States, Canada, and Sweden have significantly risen, and the central banks in these countries may continue their rate-cutting actions to address the slowdown in economic growth and pressure in the labor market.
Taking the Federal Reserve as an example, although it released a relatively "hawkish" signal at its December 2024 meeting, indicating uncertainty regarding the magnitude and timing of future rate cuts. However, Goldman Sachs believes that this statement does not signify the end of the rate-cutting cycle, but rather aligns with the historical pattern of slowing in the later stages of rate-cutting cycles.
Goldman Sachs expects that the Federal Reserve will further cut rates three times in 2025, each by 25 basis points.