Written on 9/19/2024
After being on pause for over a year, the Federal Reserve has decided to cut their target rate by .50%. Heading into the meeting I couldn’t remember a time when there was more uncertainty around a Fed decision. I could see how a case could be made for either a quarter or half of point reduction to the target rate depending on your view of the economy. Personally, I was very pleased with the decision the Fed made, not because I think we are on the cusp of an imminent recession but rather because inflation is pretty close to their target. Based on the CPI and PPI data that were released earlier this month the Fed’s preferred inflation measure, the PCE deflator is expected to come in at 2.3% for the month of August. That is close enough to their longer-term target of 2%, and much of what has been keeping the inflation data as high as it is, is the rent and owner equivalent rent components, which have a long lag to current rental rates. In regard to the other leg of the Fed’s dual mandate, the employment situation has cooled considerably, further paving the way to begin reducing the restriction on the economy. Fed Chair Jerome Powell presented the larger than typical rate cut in a way not to send recession fears into the markets. He stated that given the progress on inflation and cooling of the labor market, it is now time to begin re-calibrating policy, a term used many times throughout the speech. He also conveyed this message through his interpretation of dot plot. The dot plot showed the median Fed member’s projections of rates cut to be another half of point reduction for the remainder of this year, and a full one percent next year. I interpret the gradual easing over the next 15 months as a sign that they have faith in the soft landing. With that said, these projections rarely reflect what actually happens, which has been very evident in recent years.
The path of future rate cuts will be determined by the path of the economy going forward. To understand that, we need to understand where we currently are based on recent data. So far, we are in an economy that is moderating from very high levels. The pandemic created all kinds of distortions due to large amounts of government spending and easy monetary policy. Now most metrics are back down to levels prior to the pandemic. The consumer has remained resilient which was reflected in the latest retail sales report, however different income cohorts have felt the impacts of inflation very differently. Middle- and Upper-income earners have benefited from increasing money market rates, home prices, and equity values, while the lower income segment has seen most of their income going toward their basic living needs. Credit card debt has risen substantially, however debt payment as a percentage of disposable income remains very low. Many other metrics show a similar mixed picture. The manufacturing and housing numbers have been weak, while services have remained strong. The unemployment rate has risen substantially from the lows but is still historically very low. Payroll gains have slowed considerably with the current three-month average at 116k. Although we have become accustomed over the last year and a half to prints closer to 200k, the current average isn’t much below the longer-term average. What worries economists and market watchers is decelerating economies tend to persist downward. Although the pace of the deceleration in certain areas is somewhat concerning, there are some potential catalysts that could act as tailwinds for the economy. With current inflation data continuing to decelerate, real wages have been rising for the average worker. As long as layoffs remain at low levels for a sustained period of time, this should help fuel consumer spending. Declining borrowing costs should give corporations more confidence to purse future growth opportunities, which in turn may increase their need for additional workers. The housing market which has been frozen by higher mortgage rates and lack of inventory should see a reacceleration as rates come down. Overall, the economy is currently reflecting a soft landing, there are both reasons to be cautious as well as optimistic. Incoming data will dictate whether we lean more toward the side of caution or optimism
As for the stock market, which initially reacted marginally lower following the FOMC meeting, is now interpreting the cut very positively. The S&P 500 has broken out of a short-term ascending triangle and is making a new all time. Various momentum indicators have flipped into buy territory but are not yet at overbought levels on the daily charts. That indicates to me that this rally could have further to go in the short term. I expect volatility to stay elevated ahead of the election and would not be surprised to see some sort of pullback in the next month and a half. Valuations also remain elevated and could increase the magnitude of unwelcomed economic data. We will likely take the current advance as an opportunity to trim some equity exposure in anticipation of a minor pullback.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted.