Financial markets/economy

Rate cut does not mean low rates: why we still fear recession

Posted by MoneyController on 28.03.2024

There is perhaps a misconception in the financial markets that the interest rate cuts planned by the ECB and the Fed this year will lead to an expansionary monetary policy. In fact, interest rates will still remain high on average compared with the monetary policies in place just a few years ago.

Markets too optimistic to wait for a soft landing?

The growth in equity markets - although mainly driven by certain trends such as artificial intelligence - is a sign of optimism: indeed, it seems that the markets see a series of rate cuts and a so-called "soft landing" as the most likely scenario. In other words, markets expect the economy to emerge from a period of restrictive monetary policy without falling into recession. However, not everyone agrees that this is the most likely scenario.

A less optimistic scenario and a more likely recession

Gabriele Petrucciani reports in the Corriere della Sera on the analysis of Donatella Principe, director of market and distribution strategy at Fidelity International. The manager is convinced that the markets are overestimating the extent of the interest rate cuts and underestimating the recessionary effects of the monetary policies implemented so far (interest rate hikes). As a result, the risk of a recession (albeit a short one) cannot be ruled out.

Interest rate cuts: a less restrictive but not expansionary monetary policy

On the one hand, the European Central Bank is unlikely to cut interest rates before June, while the US Federal Reserve will not cut rates five times as many traders expect, but three times. This means that it is very likely that the cost of money will fall by the end of the year. But this does not mean that we are entering a period of expansionary monetary policy.

The recessionary effects of the cost of money have yet to be felt

It is also important to remember that the recessionary effects of monetary policy are not immediate, Principe continues. Many companies continue to enjoy very favourable borrowing rates because they borrowed at a time when interest rates were close to zero. Now that interest rates are being lowered, but slowly, many companies may find it difficult to obtain new loans, even with a slightly less restrictive monetary policy than at present.

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