As the world’s major economies navigate through a complex financial landscape that has recently seen multiple rounds of interest rate hikes, 2024 marks a significant turn towards a period of interest rate reductionsThis transition has sparked a critical inquiry among market observers and economic analysts: when and how will this cycle of rate cuts come to an end?

On the 22nd of this month, a team of analysts from Goldman Sachs, led by Jan Hatzius, released a report that sheds light on this pressing questionTheir analysis draws upon historical data regarding past monetary easing cycles, particularly focusing on the 'soft landing' scenarios observed across the G10 economiesFrom this, they have distilled three key patterns that appear to emerge consistently.

The first observation is that central banks typically conclude periods of monetary easing cautiously and gradually

Instead of abrupt stops to rate cuts, they often implement pauses in the reduction of ratesA second critical factor is that rising unemployment rates or a situation where the policy rate exceeds the neutral rate tends to encourage central banks to continue their path of reducing ratesFinally, it has been noted that central banks often prefer to lower the policy rate below the neutral level as these cycles wind down.

The report suggests that these historical patterns lend credence to the prevailing dovish expectations regarding interest rates in the G10 nationsCountries such as the United States and Canada could continue to lower their rates further in response to economic conditionsSpecifically, Goldman Sachs anticipates that the Federal Reserve will execute an additional three rate cuts in 2025, each by 25 basis points.

Analyzing the pace of these reductions, Goldman Sachs notes that history indicates a particular rhythm to rate cuts during a 'soft landing' scenario

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In the first six months of an easing cycle, central banks often initiate cuts at a relatively rapid pace, accounting for approximately 50% of the total reduction in ratesHowever, as the cycle progresses, the pace of cuts tends to decelerate significantlyData indicates that, on average, the rate of decrease drops from 1.1 percentage points to 0.7 percentage points in the months leading up to and following the cut cycle.

A common occurrence during these easing phases is the phenomenon of rate pausesOver 70% of past easing cycles featured at least one pause, with nearly half of these cycles experiencing two or more pausesThis pattern underscores a central bank’s growing caution as they adjust policies toward their target rates during the latter stages of rate cut cycles.

This gradualism also informs the overall duration of easing periods; nearly half of all 'soft landing' easing cycles have lasted over a year, highlighting that the conclusion of interest rate reductions is rarely a swift affair

Instead, this process is nuanced and detailed, requiring careful adjustments by the monetary authorities.

Two pivotal factors influence the timing of when a rate cut cycle comes to a close: the unemployment rate and the level of the policy rate relative to the neutral rateGoldman Sachs identifies rising unemployment as a variable that significantly increases the likelihood of continued rate cuts post the onset of an easing cycleThrough regression analysis, the firm found that for each one-percentage point increase in unemployment, the probability of ongoing rate cuts increases by 40 percentage pointsThis finding reflects a central bank's acute sensitivity to labor market dynamics, with shifts in unemployment being prioritized as a signal for monetary policy adjustments.

Equally significant is the status of the policy rate in relation to the neutral rateWhen the prevailing policy rate exceeds the estimated neutral rate, the likelihood of further easing typically remains high

This observation is particularly pronounced at the onset of economic recoveriesGoldman Sachs estimates that each additional percentage point above the neutral rate correlates with a 25-percentage-point increase in the probability of rate cuts.

When examining how these easing cycles usually conclude, historical data imply that they frequently end when the policy rate settles below the neutral levelOn average, the finishing point for these cycles stands about 1 percentage point below the neutral rate, and the distribution of this data exhibits a downward biasThis trend indicates that as economies approach a 'soft landing,' central banks often opt for a more lenient monetary stance.

Moreover, rising unemployment is identified as a critical driver for actioning rate cuts below the neutral rate at the tail end of easing cyclesAnalysis from Goldman Sachs reveals that with every one-percentage-point increase in unemployment, the probability of the central bank pushing rates below neutral rises by 20 percentage points

In this context, the influence of core inflation rates and GDP growth on the continuation of rate cuts appears relatively limited.

Looking ahead, Goldman Sachs maintains a dovish outlook for the monetary policy trajectories of major economies, grounded in these historical patternsThe report notes an observable uptick in unemployment rates in countries such as the United States, Canada, and Sweden, suggesting that the central banks in these regions may persist in their rate-cutting paths to confront the dual challenges of sluggish growth and employment market pressures.

Specifically focusing on the Federal Reserve, it is noted that despite having signaled a more hawkish tone in its meeting scheduled for December 2024—implying uncertainties surrounding the magnitude and timing of future rate cuts—Goldman Sachs contends that this stance does not signify the cessation of the easing cycle