Resources/Weekly Insights

Volume 13, Edition 23 | September 14 - September 20, 2024

Reading the Fed’s Tea Leaves

Doug Walters, CFA

The Fed cut rates greater than expected. Was this a signal of confidence or concern? Investors weighed in this week.

Contributed by Doug Walters, David Lemire, Max Berkovich

The Federal Reserve’s recent decision to cut interest rates more than anticipated has ignited a spirited debate among economists, investors, and market watchers. Is this bold move a victory lap in the battle against inflation, or does it hint at deeper worries about the economy’s health? Does it even matter?

An Inflation Victory

Inflation is down – a lot. In June 2022, CPI inflation was a staggering 9.0%. The latest figure is a much more palatable 2.6%. While prices haven’t exactly rolled back to 2019 levels, deflation is a whole other problem with potential undesirable outcomes… economic decline, rising unemployment, and declining stock prices.

The Fed is keen to avoid deflation, and this week’s rate cut is partly to steer clear of the so-called “hard landing.” But does the larger-than-expected cut suggest the economy is in worse shape than we thought?

Economic Cracks?

The Fed has a dual mandate: price stability (aka taming inflation) and maximizing employment. Proponents of the “things are worse than we know” camp point to the recent uptick in unemployment as the driver of the Fed’s large cut. The unemployment rate has crept up to 4.2% from a post-pandemic low of 3.4%. While the rise is indisputable, these are still historically low unemployment rates. The median unemployment rate of the past 30 years is 5.1%. So, in isolation, 4.2% is not concerning. But the trend is undeniably upward.

The Fed recognizes that any rate change it makes today will take time to ripple through the economy. Studies suggest the lag could be anywhere from nine months to two years. So, while the economy may not be worse than we think, the Fed’s decision to go big could be insurance that they do not fall behind.

Choose Your Version

So, was the big cut the act of a Fed confident about inflation or a shot across the bow on the economy? The ultimate arbiter of the truth is the market. Stocks have exhibited some volatility but ultimately ended the week slightly up. Given the recent strength of the stock market, I read this as a sign that investors still see a soft landing as a strong possibility.

As evidence-based investors, we are not in the business of fortune-telling. Time alone can author the ending of this story. But history teaches us that the old adage, “don’t fight the Fed” is true more often than not. As the Fed cuts rates, all else equal, borrowing becomes more accessible, and economic activity picks up. With that in mind, we caution investors who may be reading too much into the large rate cut. Instead, stay invested and focus on diversification, as yesterday’s winners may not be tomorrow’s in this new rate paradigm.

0.5%

Cut in the Fed Funds Rate

The Federal Reserve cut their target federal funds interest rate by 50 basis points on Wednesday to a range of 4.75-5.00%.

Headline of the Week

The Powell Pivot

After much consternation among interest rate traders, the Fed finally relieved the tension and cut rates by half a percent rather than the more normal quarter percent. Markets initially took the move in stride, although there was a bit of volatility. After sleeping on it, markets woke and decided they liked the move a bit more, and equity markets rallied (broadly around 1%). Post-announcement comments were centered on the Fed’s desire to contain labor market softness and stick the soft landing. Officials’ rate projections show a steady decline towards just under 3% by the end of 2027, but a lot can change before then.

The Week Ahead

The S&P 500 index notched its 39th record close on Thursday after the jumbo cut from the Federal Reserve on Wednesday. The new week will try to keep that momentum going with an inflation report, and Fed speakers post the quiet period.

Down We Go!

Friday will bring an inflation print from the Federal Reserve’s preferred measure, the Personal Consumption Expenditures Index (PCE).

PCE is expected to come in at 2.5% on an annual basis, with the core PCE, which excludes food and energy, coming in at 2.7%.
Current projections have the headline inflation trickling down to 2.3% by year-end and 2.1% by the end of 2025.
The trajectory of the readings will impact how many more times the central bank will have cover to trim rates.
Post meeting, many central bankers will be free to make speeches, so look for some more color on why the big cut.
A final reading of the Gross Domestic Product on Thursday is not expected to move any needles.

Bankers Box

While the most prominent central banks are out of the way, several other major central banks have meetings.

Reserve Bank of Australia, Swiss National Bank, and Riksbank (Sweden’s central bank) are on the clock.
The Swiss National Bank is expected to cut, but there is not much certainty if that will be a ¼ or ½ of a percent.
Australia’s inflation has started to cool, which takes hikes off the table, but consensus is that they will stand pat this time.
Sweden is expected to cut a quarter this time, as inflation is now running below the bank’s target.

Managing Purchases

A heap of Purchasing Manager Index (PMI) readings from the European Union and Japan will have renewed interest as inflation readings start to calm down. At home, we also get a fresh look at consumer spending.

PMI readings are used to keep a pulse on the business cycle, so as inflation hands the baton over to the debate of soft landing versus recession in the developed world, these readings may gain more attention.
Along with the various inflation indicators, the PCE release will also shed some light on the purchasing behavior in the U.S. with personal spending and personal income reads.
Friday, we will get a University of Michigan Consumer Sentiment Index reading as well.

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