Assume you are a wall street analyst, provide evidence to prove or disprove the assertion that the economy and therefore the stock market enters a recession 6 to 18 months after the first rate cut by the Fed after a period of tightening. Provide statistics of the probability of recession if the assertion is proven to be probable. Provide a chain of thought.
The assertion claims that after the Federal Reserve tightens policy (hikes rates) and then initiates the first rate cut, a recession typically follows within 6 to 18 months, implying the economy and stock market weaken accordingly.
To evaluate this, I reviewed historical Fed hiking and easing cycles since the 1950s-1960s (focusing on post-1965 or post-1980 data from reliable sources like CFA Institute, NBER recession dates, and analyses from CME, Northern Trust, and others). Key is distinguishing "insurance" or "mid-cycle" cuts (preventive easing without imminent recession) from cuts responding to or coinciding with economic downturns.
Historical hiking cycles often end with easing, but not all easing leads to recession promptly. Out of ~12 hiking cycles since 1965, ~8 led to recessions (often because hikes overtightened). For easing cycles after tightening:
- Sources identify 7-11 distinct post-tightening easing cycles since 1980 (e.g., 1984, 1989, 1995, 1998, 2001, 2007, 2019).
- In most cases (~70-80%), easing coincided with or occurred during/near a recession (e.g., 2001 dot-com, 2007-08 financial crisis).
- However, notable exceptions: 1995 ("soft landing" preventive cuts, no recession), 1998 (Asia/Russia crisis insurance cuts, no U.S. recession), 2019 (mid-cycle adjustment, no recession before COVID).
Thus, the assertion is partially true but not consistently probable. Recessions often follow the first cut (especially if cuts respond to weakness), but ~30-40% of cases (3 out of ~10-11 recent cycles) avoid recession entirely, with cuts acting as successful prevention. Timing varies: recessions can start before the first cut, concurrently, or 6-12 months after—not strictly 6-18 months post-cut.
Probability: Based on post-1980 data, ~60-70% chance of recession during or shortly after the easing cycle starts. (E.g., one analysis: 2 out of 10 cycles avoided recession entirely; another implies ~50% non-recessionary.)
For the stock market: Contrary to the assertion implying decline, S&P 500 performance is generally positive after the first cut:
- Average/median 12-month return: +11.9% to +14.1% across cycles.
- Stronger in non-recessionary cases (+17-30% annualized in some studies).
- Weaker or negative in recessionary cases (e.g., -2.9% annualized average during recessions).
Evidence comes from aggregated historical analyses (CFA Institute, Northern Trust, RBC, LPL Financial), cross-referenced with NBER recession dates and Fed funds rate history.
Conclusion: Disproving the Assertion as a Reliable Rule The assertion is not strongly supported as a high-probability outcome. While recessions frequently occur around the shift from tightening to easing (often because prior hikes slow the economy), the first rate cut after tightening does not reliably cause or signal a recession within 6-18 months in all cases. Preventive ("insurance" or mid-cycle) cuts have successfully averted recessions ~30-40% of the time since 1980 (e.g., 1995, 1998, 2019).
- Probability of recession following the first post-tightening cut: Approximately 60-70% historically (based on ~7-8 recessionary out of 10-11 cycles post-1980). This is elevated but far from certain—higher than baseline but not "probable" enough to treat as inevitable.
- Timing is inconsistent: Recessions often start near or before deep cutting begins, not strictly 6-18 months after the initial cut.
For the stock market, the pattern contradicts a recessionary decline: S&P 500 averages positive returns (~+12-14% in the year after first cut), with stronger gains in non-recessionary scenarios. This reflects lower rates boosting valuations and growth, unless a full recession hits.
In summary, the Fed's pivot to cuts often reflects late-cycle conditions with elevated recession risks, but successful soft landings occur meaningfully often. The assertion overstates the inevitability and underestimates positive stock market outcomes in non-recessionary cases. Investors should monitor leading indicators (e.g., yield curve, unemployment trends) rather than assume recession post-cut. |
