Is There Too Much Focus on Fed’s Moves?

Mar 6, 2025

The discussion dives into the significance of Federal Reserve rate changes on the markets. Andrew Sheets argues that frequent cuts may not be as beneficial as investors believe. Instead, he emphasizes the need for stability in monetary policy. Other factors, like US trade and immigration policies, play a crucial role in shaping market conditions. The conversation challenges listeners to reconsider their focus on the Fed’s moves and the potential advantages of a more consistent approach.

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INSIGHT

Fed's Importance and Stability

The Federal Reserve's actions significantly impact financial markets, particularly interest and inflation rates.
Investors should prioritize stability in Fed policy over frequent changes.

INSIGHT

Stable Fed Rate Expectations

Despite global events, expectations for the Fed's interest rate path have remained relatively stable since late 2024.
A stable Fed funds rate typically indicates a stable economic equilibrium.

ANECDOTE

Historical Growth and Rate Changes

The mid-1990s saw strong economic growth after the Fed made minor interest rate reductions and maintained stability.
Conversely, significant rate changes often coincide with economic slowdowns and market losses.

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While central bank policy will always matter for markets, our Head of Corporate Credit Research Andrew Sheets explains why investors should not be worried about the number of Fed cuts in 2025.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. Today I’m going to talk about why the number of Fed rate cuts this year may matter less than you think.

It's Wednesday, March 5th, at 2pm in London.

Financial markets spend a lot of time discussing the Federal Reserve. And for good reason. The central bank of the world’s largest economy plays a central role in fighting inflation and setting interest rates. And what they’ll do this year is topical and shifting. At Morgan Stanley, our economists think that US Tariff and Immigration policy will lead the Fed to keep rates somewhat higher, for somewhat longer, than they did at the start of the year.

Yet we think there may be just a little bit too much focus on just how much the Fed changes policy over the course of the year. Indeed, we’d go as far as to say that given the choice, investors should be rooting for less change, not more.

To start, for all that’s happened in the world since the end of October of 2024, expectations for the Fed’s interest rate path have been remarkably stable. The US 2-year Treasury, which is a decent proxy of where the Fed’s rate will average over the next 24 months, has hovered in a very narrow range. It simply hasn’t been telling us very much; other factors have been moving markets.

There’s also a pretty reasonable rule of thumb from history: stability is good. A stable Fed funds rate, almost by definition, implies a stable equilibrium that doesn’t involve overly high inflation pushing rates further up, or overly weak growth pushing them further down. The best growth in recent history, in the mid-1990s, occurred after the Fed reduced interest rates less than one-percent, and then kept them stable, at a pretty elevated rate for a pretty extended period of time.

Large changes in rates, on the other hand, in either direction are a different story. Some of the markets worst losses have coincided with the largest declines in the Fed’s target rate – because those large rate cuts usually occur only when there is a large, unexpected slowing in the economy; something markets often don’t like.

Meanwhile, we think the Fed also very much wants to avoid a scenario where it has to start raising rates again, given the potential confusion that this could signal after it only recently continued to lower them. And so if over the course of this year, the Fed does need to raise rates, given the very high bar we think they’ve given themselves for action – it probably suggests that something unexpected, and not in a necessarily good way, has occurred.

Central bank policy will always matter for markets. But for investors, the question of whether the Fed will cut once, which is the Morgan Stanley base-case, twice, or not at all in 2025 may not matter all that much, at least for credit. Far more important is the performance of the economy, and whether big changes to tariffs or immigration policy drive big changes to growth and inflation. Those big changes, which could drive big changes in Fed policy responses, are the scenario that worries us.

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