Are renewed Fed rate cuts a sign of recession risk? Barclays weighs in.

Investing.com - A renewal of Federal Reserve interest rate cuts may have historically been indicative of increased recession risk, but doesn’t necessarily imply one, according to analysts at Barclays.

In a note to clients, the bank flagged that in seven instances of the Fed resuming a rate-cutting cycle after a significant pause over the last five decades, four were followed by an economic downturn. Three of them, however, preceded periods of expansion.

For equity markets, stocks continued to grind steadily higher and outperformed bonds in the instances when renewed rate cuts were not followed by a recession.

"But where a recession unfolded, equities mostly dropped after the cut, although they bounced back over the course of the next 12 months, and bonds outperformed at least initially," the analysts led by Emmanuel Cau said.

The Fed is widely anticipated to slash borrowing costs at its upcoming September 16-17 gathering, with officials keen to support a possibly weakening labor market.

In theory, rate reductions can help spur on investment and hiring, albeit at the risk of driving up inflationary pressures.

Economists are predicting that price gains remained stubbornly elevated last month, fueled in part by sweeping U.S. tariffs. But policymakers have hinted at a willingness to prioritize a deteriorating jobs picture, especially amid recent monthly data that has come in softer than anticipated and preceding figures that have been revised sharply lower.

In the wake of a weak August jobs report released last week, expectations for a drawdown by the Fed of at least 25 basis points have been all but cemented. There is also a roughly 10% chance of a deeper, half-point cut from the current level of 4.25% to 4.5%, CME’s FedWatch Tool has shown.

It would be the first time the Fed has lowered rates since December, when the central bank halted a series of cuts amid indications of easing inflation at the time.

Against this backdrop, the Barclays analysts predicted that lower rates could fuel more persistent gains in stocks and a "broadening of leadership" in equities into "cyclical laggards."

"However, rising unemployment still poses a risk, and with equities close to the highs and volatility near lows, this arguably creates a negative asymmetry for equities if the Fed fails to deliver a soft landing for the labor market," they wrote. They added that hedging left tail risk, or the possibility of extreme negative outcomes for an investment, "makes sense."