The Fed is bracing for a familiar cautionary tale from 1985-86, as investors seem to anticipate an aggressive round of interest rate cuts despite the absence of a recession. Nicholas Colas of DataTrek Research suggests that market participants should revisit history and adjust their expectations.

Fed-funds futures traders are pricing in five to six quarter-point rate cuts this year, in contrast to the Fed’s projection of three cuts in 2024. This optimism is linked to expectations that the Fed will maintain real interest rates if inflation continues to decline.

While stocks soar to new highs, DataTrek’s analysis of past easing cycles highlights a rare occurrence in 1985-86 when the Fed cut rates by 1.25 percentage points within a non-recessionary period. Colas points out that this led to a significant stock market rally, culminating in the infamous Black Monday in 1987.

Colas emphasizes the Fed’s awareness of this cautionary tale and suggests that, given the current lower policy rates, the central bank has added reason to proceed cautiously in 2024. Without an imminent recession, there is no precedent for such substantial rate cuts this year.

Colas acknowledges the possibility that fed-funds futures may be signaling a potential recession, but he remains skeptical, attributing the market’s stance to a bet on the Fed becoming less restrictive as inflation declines. Despite the mathematical validity of this view, Colas contends that it doesn’t align with historical data or the Fed’s institutional memory.

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