A Foolish Take: How Big Will the Federal Reserve's Next Move Be?

History suggests a likely answer.

Dan Caplinger
Dan Caplinger
Jul 22, 2019 at 12:01PM
Investment Planning

The Federal Reserve has control of monetary policy in the U.S., and given some of the recent economic hiccups that we've seen recently, there's been a lot of speculation about whether the Fed will step in to cut interest rates from the current range for its federal funds rate of 2.25% to 2.50%. Any such move would come as a reversal of the Fed's previous policy direction, as the central bank raised interest rates on nine different occasions between 2015 and 2018, including four moves last year alone.

Increasingly, the things that Federal Reserve officials have said publicly suggest that a rate cut is extremely likely. That's shifted the debate to the likely size of a rate cut. Some point to the fact that every move that the central bank has made over the past decade has been a quarter percentage point as evidence that another such move is most probable. Yet some think that a half-point cut could be more effective, essentially allowing the Fed to support the economy in one fell swoop without the need to revisit the question repeatedly in the future.

Over time, the Federal Reserve has developed a pattern of being conservative with its policy moves. As you can see below, quarter-point cuts are far more common than half-point moves, and the central bank has only made larger cuts in a handful of situations.

Bar chart showing rate cuts by Federal Reserve since 1990

Data source: Federal Reserve Bank. Chart by author.

Those who favor a half-point cut this time around will note that such large reductions are far from unusual. In fact, during the recession of 2000 to 2002, half-point moves were the norm, with only occasional quarter-point reductions to slow the overall pace of declining rates.

However, one thing to keep in mind is that rates are already extremely low. Double-digit rates were common as recently as the late 1980s, and periods of rate decreases since then have generally started with rates somewhere between 5.25% and 6.5%. When rates are high, it can take larger moves to have the desired effect. When rates are low, the Fed doesn't have as much room to make cuts at all -- let alone larger ones.

Market participants are divided on whether a quarter-point or half-point cut will happen. But they tend to agree that some cut is extremely likely -- and could happen as soon as the end of July, with significant implications for stocks and other financial markets.