Historical Rate Cuts and Economic Soft Landings

The global economic landscape is undergoing a significant transformation as major economies pivot from a phase of interest rate hikes towards a potentially lengthy easing cycle in 2024. After a series of aggressive rate increases aimed at curbing inflation, the financial world is now turning its attention to the pressing question: when and how will this easing cycle come to an end?

On the 22nd of the month, a team of analysts led by Jan Hatzius at Goldman Sachs released a comprehensive report that draws upon historical analyses of "soft landing" monetary easing cycles across G10 economiesThey identified three crucial patterns that could provide guidance on the potential trajectory of current monetary policies.

Firstly, central banks are generally inclined to wrap up easing cycles slowly and cautiously, often by pausing rate cutsSecondly, a rise in unemployment, combined with policy rates remaining above neutral levels, tends to encourage further reductions in rates

Thirdly, central banks typically prefer to set policy rates below neutral rates as the easing cycle progresses.

The findings of the report bolster current dovish expectations for interest rates in G10 countries, with predictions that the Federal Reserve and other nations like Canada could potentially continue their path of rate cutsNotably, Goldman Sachs foresees the Federal Reserve making three additional rate cuts in 2025, each by 25 basis points.

One of the standout conclusions from the report is that the pace of interest rate decreases during easing cycles tends to follow a pattern where cuts are initially rapid but gradually slow down as time progressesSpecifically, during the first six months of a rate-cutting cycle, it is common for central banks to implement approximately 50% of the total anticipated reductionsHowever, this momentum tends to wane in the latter stages of the cycle

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Analysis shows that in the months surrounding a rate-cutting period, the average decrease changes from about 1.1 percentage points initially to around 0.7 percentage points toward the end.

Moreover, the phenomenon of pausing rate cuts is frequently observed, with over 70% of easing cycles in history witnessing at least one instance of a pause, and nearly 50% experiencing two or more pausesThis indicates a conservative approach by central banks as they transition through the later stages of rate cuts, gradually adjusting policies to align with target rates.

Historical patterns suggest that nearly half of the "soft landing" easing cycles extend beyond a year, indicating a deliberate and nuanced approach to monetary policy adjustments rather than abrupt changes.

Two pivotal factors emerge from Goldman Sachs’ analysis when considering the termination of easing cycles: unemployment rates and the positioning of policy rates in relation to neutral rates

An increase in unemployment after the initiation of an easing cycle notably raises the likelihood of further rate cutsFor instance, the report reveals that for every 1% rise in unemployment, the probability of continuing rate cuts increases by a significant 40%. This response highlights the central bank's acute sensitivity to labor market dynamics, viewing unemployment fluctuations as critical signals for policy adjustments.

In addition to unemployment, the level of the policy rate itself plays an integral role in this equationShould the current policy rate exceed the central bank's estimation of the neutral rate, the probability of extending the easing cycle remains highThis is particularly evident in the early stages of economic recovery, with estimates suggesting that for every 1% by which the policy rate surpasses the neutral rate, the probability of continued easing increases by 25%.

The data reveals a distinct trend: G10 nations typically conclude their easing cycles when the policy rate dips below the neutral level

On average, the endpoint of an easing cycle tends to be about 1 percentage point lower than the neutral rate, with a downward distribution indicating that as the economy nears a "soft landing," central banks are prone to adopt more accommodative monetary policies.

The rise in unemployment serves as a primary driver for policy adjustments during the culmination of easing cyclesGoldman Sachs' analysis further demonstrates that a 1% increase in unemployment amplifies the odds of the policy rate dropping below the neutral threshold by 20%. In contrast, changes in core inflation rates and GDP growth appear to exert a considerably lesser influence on the decision to continue easing.

Looking ahead, Goldman Sachs maintains a dovish outlook on the future directions of monetary policy in major economies, in light of these established historical patternsThe report points out a notable rise in unemployment in nations like the U.S., Canada, and Sweden, suggesting that the respective central banks may persist with further rate cuts to combat sluggish economic growth and mounting pressure in employment markets.

For instance, despite the Federal Reserve signaling a somewhat hawkish stance during its December 2024 meeting, by expressing uncertainty regarding the magnitude and timing of future rate cuts, Goldman Sachs interprets this signal differently

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