Emergency rate cut unlikely despite rising recession fears, economists say

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Economists believe the United States Federal Reserve and the Bank of Canada may cut their policy rates faster than previously expected after fears of a potential U.S. recession sparked a wave volatility in global financial markets over the past week.

Monday’s market sell-off — in which the Dow Jones industrial average plunged more than 1,000 points and more than US$6.4 trillion was wiped from global markets, according to Bloomberg News — came in the wake of a U.S. jobs report Friday that showed U.S. unemployment had risen unexpectedly to 4.3 per cent in July.

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Monday’s plunge prompted at least one observer, economist Jeremy Siegel of the Wharton School of Business, to call on the Federal Reserve to make an emergency rate cut of 75 basis points, but most thought such a move would be premature and instead predicted the pace of interest rate cuts will accelerate.

“I think emergency rate cut talk is absurd to be honest and conditions would have to get vastly worse to merit an emergency cut,” said Derek Holt, vice-president and head of Capital Markets Economics at Scotiabank. “We’re nowhere close and we may already be stabilizing. Plus, it’s August, so we must reserve some judgment given that it’s a time of year when market volumes and volatility can behave erratically.”

While markets showed signs of calming Tuesday, the soft U.S. economic data is something the Fed and the Bank of Canada will be watching closely as they make their next rate decisions.

“Our take on this is that we did add an additional Fed and Bank of Canada cut,” said Katherine Judge, economist with the Canadian Imperial Bank of Commerce. “We don’t think an inter-meeting cut is likely, they (the Federal Reserve) would only do that in the case of a total meltdown in financial markets, which we are not seeing.”

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Stephen Brown, deputy chief North America economist at Capital Economics, thinks the depth of those cuts will really depend on if more U.S. data out next week show a continuation of declines.

“If we did see actual concrete signs of a U.S. recession taking hold, the bank would have to feed that through its own economic forecast,” said Brown. “I think in that scenario, if the Fed were to cut by 50 basis points or more at the forthcoming meeting, the Bank of Canada may decide to go quicker as well.”

Bank of Canada Governor Tiff Macklem told the Financial Post following a July decision to cut rates for the second consecutive meeting, that the central bank’s balance of worries is shifting and that it is now concerned that inflation could fall below its two per cent target.

Beata Caranci, chief economist at Toronto-Dominion Bank, thinks markets overreacted on Friday and have to also adjust to this shift in risks to the economy.

“They’re thinking through we are at a different point at the cycle now, so we had almost an entire year that the data was surprising to the upside and now we’re on the other side of that,” Caranci said. “Now we’re getting data that for the past three months has on average surprised to the downside and so there is that adjustment process happening in the pricing markets.”

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Holt thinks the Bank of Canada should remain cautious in how it pursues its rate cuts.

“Cutting too fast and too aggressively with very dovish guidance risks resurrecting inflationary forces,” Holt wrote in a note to clients. “The economy is resilient, and inflation risk remains elevated, so be careful in crafting monetary policy.”

There is precedent for emergency rate cuts. In 2001, the Federal Reserve made two unscheduled cuts following the tech bubble burst and the Sept. 11 terrorist attacks. There were also two unscheduled cuts following the 2008 financial crisis and most recently, during the COVID-19 pandemic.

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