• Insurance Directions
• March 25, 2025

How Did the Interest Rate Cuts Come to an End?

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In a significant shift marking the beginning of a new economic chapter, global economies are currently embracing a cycle of interest rate cuts as we venture into 2024. This transition follows a lengthy period of rising interest rates as central banks attempted to combat inflationWith this easing of monetary policy, the focus of financial markets is increasingly directed towards an intriguing question: when and how will this cycle of rate cuts come to a close?

Recent insights from Goldman Sachs, by an analytics team led by Jan Hatzius, provide an illuminating perspective on the historical precedents of monetary easing within the G10 economiesTheir report highlights three prevailing trends that have characterized the cessation of previous cycles of rate cuts during periods of economic stabilization.

First, central banks typically exhibit a deliberate and cautious approach when concluding a period of monetary easing

Often, this is signified by a pause in rate cuts, which serves as an indicator of the central bank's careful navigation towards a balanced economic landscapeSecond, a notable rise in unemployment or a scenario where the policy interest rate surpasses the neutral rate can lead to continued rate cutsLastly, these institutions tend to lower the policy rates beneath neutral levels, indicating an inclination to provide additional stimulus even as economic conditions normalize.

The analysis posits that such trends lend credence to the prevailing dovish expectations surrounding interest rates in the G10 countriesThis expectation is notably pertinent for central banks like the Federal Reserve in the United States and Canada, which may persist with their current trajectory of rate reductionsGoldman Sachs further forecasts that the Federal Reserve will likely implement three additional rate cuts in 2025, each by 25 basis points.

Examining the rhythm of these rate cuts reveals a discernible pattern: a rapid commencement followed by a gradual deceleration in the pace of reductions

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Historical data suggests that during the initial six months of a rate-cutting phase, central banks often engage in aggressive easing, executing approximately half of the total rate reductions in this periodHowever, as time progresses, the cadence of rate cuts noticeably slowsFor instance, the average reduction shrinks from 1.1 percentage points in the early months to 0.7 percentage points towards the latter stages of the cycle.

This caution is further underscored by the prevalence of pauses during rate-cutting cycles; over 70% of observed cutting periods have incorporated at least one pause, with nearly half experiencing multiple interruptionsSuch tendencies indicate a strategic pivot by central banks as they approach their target rates, illustrating a careful recalibration of monetary policy amid changing economic landscapes.

The intricacies of the labor market also play a pivotal role in dictating the trajectory of rate cuts

Goldman Sachs identifies two critical factors: the unemployment rate and the positioning of the policy interest rate relative to the neutral rateAn increase in the unemployment rate during a rate-cutting cycle substantially heightens the likelihood of continued reductionsTheir regression analysis shows a striking correlation where a 1-percentage-point increase in unemployment correlates with a 40-point uptick in the probability of further rate cutsThis sensitivity illustrates how closely central banks monitor labor market conditions in their decision-making processes, positioning unemployment data as a critical parameter in monetary policy adjustments.

Equally essential is the relationship between the policy interest rate and its neutral counterpartTypically, when the prevailing policy rate exceeds the central bank's neutral rate assessment, the potential for ongoing rate cuts remains high

This relationship is particularly pronounced in the nascent stages of economic recovery; Goldman Sachs estimates that for every 1-percentage-point excess of the policy rate over the neutral rate, the probability of further cuts escalates by 25 points.

Historically, G10 economies have displayed a tendency to conclude their rate-cutting cycles when policy rates dip below neutral levelsOn average, the termination point of rate cuts lags 1 percentage point beneath the neutral rate, with a distribution that tends to skew downwardThis trend indicates that as the economy approaches a "soft landing," central banks are inclined towards a more accommodative monetary stance.

Furthermore, the rise in unemployment is recognized as a significant driver behind the policy overshoot at the conclusion of a rate-cutting periodGoldman Sachs observes that each 1-percentage-point increase in unemployment amplifies the probability of the central bank lowering the policy rate beneath the neutral threshold by 20 points

In contrast, factors such as core inflation and GDP growth exert comparatively limited influence on the continuation of rate cuts.

Looking ahead, the forecasts from Goldman Sachs suggest a prevailing dovish trajectory for monetary policy among key global economies, bolstered by historical patternsThe report indicates that countries like the U.S., Canada, and Sweden have already witnessed significant upticks in unemployment, prompting their respective central banks to potentially maintain or even pursue further rate cuts to address economic slowdowns and mounting labor market pressures.

Taking the Federal Reserve as an example, despite issuing relatively hawkish signals during its December 2024 meeting, which pointed to uncertainties surrounding the magnitude and timing of future rate cuts, Goldman Sachs interprets this communication as not signaling the closure of the rate-cutting cycle