3 reasons rate cuts won't stimulate the economy like they have in the past: Morgan Stanley Wealth Management CIO

• The Fed has started cutting rates, but it's not likely to boost the economy much, Lisa Shalett says.
• The economy is less rate-sensitive than it was during previous rate cuts, Shalett argues.

Rate cuts have long been seen as an integral part of the Federal Reserve's monetary policy toolbox to juice up the economy.

However, don't expect rate cuts to save the economy this time around, according to Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

Investors may have reacted positively after the initial 50-basis-point cut, but Shalett believes rate cuts have already been largely priced in from here on out. Beyond the stock market, several parts of the economy aren't very sensitive to interest rate cuts and won't see much upside either.

Today's economy is facing different challenges than it has in past cutting cycles. In an interview with Business Insider, Shalett shared what to expect — and not expect — from this cutting cycle.

3 reasons rate cuts won't work

First, companies today are carrying more cash, resulting in stronger balance sheets.

Many also locked in low borrowing rates after the Global Financial Crisis. The average cost of capital for the biggest companies in the index is only 4.2%, according to Shalett. With less debt, and subsequently fewer interest payments, many S&P 500 constituents aren't that exposed to interest rate risk.

Household consumption also points to reduced rate-cut relief. Wealth is disproportionately concentrated across American households, Shalett said, with the top 40% of households driving two-thirds of total consumption.

"For those households with net savings, high interest rates were actually stimulative," Shalett said. High-income households with extra cash on hand benefited from increased interest income in a higher-rate environment.

One example is baby boomers, many of whom live off of fixed incomes in retirement. "For them, lower interest rates are not stimulative. It's actually net reductive to their incomes," Shalett said.

While lower interest rates could potentially spur consumption for lower-income households, this group makes up only a small portion of overall spending, so don't count on that to materially stimulate the economy, she said.

Lastly, the housing market poses a large challenge for the economy, and Shallett doesn't believe rate cuts will be able to improve the situation.

Lower mortgage rates can help housing affordability, but they won't solve the underlying issue of housing inventory undersupply. According to Shalett, the US is about 4 million housing units short, thanks to a lack of construction after the housing crisis.

In addition to a dearth of supply, how homes are financed also poses an issue.

"Forty percent of the entire housing stock of the US is now owned outright with zero mortgage," Shalett said. That means homeowners are disincentivized to sell into a housing market where mortgage rates — while down from earlier highs — are still hovering around 6%. Many of these homes are owned by retired baby boomers, Shalett added.

Another 36% of the housing market has a mortgage locked below 4%, thanks to record-low pandemic interest rates.

"So the fact that mortgage rates are at 6% today doesn't really create an incentive for those people to transact in the mortgage market," Shallett said. "Seventy-six percent of your entire housing market is frozen and is not moved by the rate cuts."

Keep an eye out for corporate earnings

If rate cuts won't significantly kickstart the economy, then what will?

In Shalett's view, the economy's success hinges on increasing corporate productivity. Shalett recommends that investors closely monitor corporate earnings for the upcoming quarters.

Earnings expectations are already quite ambitious for the next year — Wall Street is forecasting 13-14% profit growth in 2025, a tall order in a slowing economy.

However, a productivity-driven rebound isn't out of the question. Companies are still reporting above-average capital expenditures, and government stimulus will boost areas of the economy such as infrastructure and energy. And the promise of AI could also drive productivity gains. All of these factors could lead the economy to a soft landing.