Updates

After today’s rate cut, is the Fed ready to pause?

• Chair Powell and the FOMC had their final meeting of the year today and announced a 0.25 percentage point cut to the overnight borrowing rate. In addition to the rate announcement, Chair Powell provided guidance to the Fed’s interest rate path moving forward. He stated that the Fed now expects two rate cuts in the next year which was an appreciable downward adjustment from prior expectations of four potential cuts. The markets were not receptive of this news and sold off.

• It is largely believed that the Fed made the additional cut because of the cooling labor market – while layoffs are not increasing, neither is hiring. The unemployment rate began the year at 3.7% and has slowly increased over the year to 4.2%. The rate cut comes despite the prolonged battle against inflation, and growing fears that Trump policies could be inflationary. Last week, the most popular inflation readings, CPI and PPI, released their monthly figures for November. The Consumer Price Index (CPI) largely met expectations, but the core CPI figure continues to hover above the 3% mark. The Producers Price Index (PPI) posted a 3% annual increase, the largest annual increase since February 2023. With several inflation readings remaining appreciably above the Fed’s target of 2%, the argument for continued appreciable rate cuts is becoming more tenuous.

• A number of important economic releases occur this week and they will have a significant impact as we enter 2025. Manufacturing data released on Monday signaled that U.S. factories are experiencing their highest level of activity in nearly three years. Tuesday, U.S. Retail had a month over month gain that beat expectations and showed the resiliency of the U.S. consumer. Today, Wednesday, housing data released was a mixed bag with a decline in housing starts but a significant increase in single family housing starts and building permits. On Thursday, additional housing data will be released along with jobless claims. Finally on Friday, to cap off the week, the Fed’s preferred inflation gauge, the personal consumption expenditure (PCE) figure will be released. Expectations are that it will indicate a 2.8% annual increase in prices for November, an appreciable increase over October’s annual reading of 2.3%.

Higher for longer after all…

• Equity markets participants showed their approval of the re-election of President Trump as the markets surged to record highs in the following days.  Further adding to market sentiment was Fed Chair Powell’s announcement of a quarter percentage point cut to the overnight lending rate. Some of the initial post-election market enthusiasm faded as global geopolitical risks escalated. International tensions escalated following the U.S. authorization for the Ukraine to attack Russian territory of Ukraine’s with American supplied long-range missiles. Somewhat counterintuitively, long-term interest rates have surged in recent days to 6-month highs on growing fears that Trump Administration policies could reignite inflationary pressures.

• The Fed’s chair stated that “the economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.”  On the back of these announcements, experts reduced the likelihood of a December rate cut to 60% from prior expectations of an 80% likelihood. Additionally, traders have reduced expectations of rate cuts by 1 percentage point with forecasts now anticipating overnight rates of 3.9% by year-end 2026 rather than prior forecasts of 2.9%

• On the inflation front, last week’s Consumer Price Index (CPI) and Producers Price Index (PPI) data were released with both figures meeting expectations. The CPI showed an annual increase of 3.3% with more than half of the gain being attributed to housing costs. The PPI print came in at 2.4% – a stark increase from the previous month of 1.9%. Both figures, echoing Chair Powell’s commentary, indicated that there are some inflationary components that remain elevated and may be taking longer than previously anticipated to decline to more acceptable levels.

Presidential Election & Federal Reserve meeting have market anxious…

• The Presidential election is finally here, and the race remains a dead heat with pollsters saying the race is a coin toss. Given how close the race is, a winner is not anticipated to be known for days. However, investors have been trying to position their portfolios based upon their expected winner. With the race being so close, this is likely a fool’s errand.
• The leaders of the US central bank are set to meet this week, their second to last meeting for the year. Currently, the market is predicting a near certainty, a 98% chance, for a quarter percentage point rate cut thus reducing overnight interest rates to a range of 4.50%-4.75% from its current range of 4.75%-5.00%. Overall, economic activity remains promising.

• The latest GDP readings had the economy has growing by a 2.8% annualized rate of growth over the last quarter. Inflation has continued to decline with the latest PCE reading in September of 2.1%, almost achieving the Fed’s 2% goal. On the downside, employment reports for August and September were revised lower, and payroll growth in October is expected to be much weaker, emphasizing that wage growth is cooling. A primary contributor to the negative payroll/jobs data has been the ongoing Boeing strike which was just resolved this morning.

• Meanwhile, equity markets continue their ascent on the back of modest 3^rd quarter earnings growth while bond markets have proven to be more volatile. The US Treasury 10-year yield, the benchmark for the corporate bond market, has risen 18% in the last two months to 4.30%. This is a result of the bond market anticipating slower and fewer rate cuts than what the Federal reserve anticipated and concerns over the inflationary impact of the proposed policies of the two presidential candidates. Expectations are for elevated volatility in coming weeks as additional clarity on the incoming presidential Administration and the Fed’s direction is found.

Hot jobs markets surprises many…

• The Department of Labor released its September jobs report on Friday containing a number of surprises. The Street expected the unemployment rate to stay at its most recent 4.2% level, and instead the reading came in lower at 4.1%. Further, employers added 254,000 new positions in September which was 40%+, or 100,000 more, than economists had anticipated.  Lastly, the report revised data from prior summer months to show that employers actually created an additional 72,000 more jobs than initially reported.

• Until this jobs report was released, investors were predicting that the Federal Reserve would cut the Fed Funds rate by a total of 1.25 percentage points before year end. Given the 0.50 percentage point rate cut last month, expectations for further rate cuts before year-end were high. As a result of this jobs report, analysts are now expecting much less aggressive action by the Fed’s rate setting committee. Partially as a result, the benchmark 10-Year Treasury rate has climbed almost 10% within the last month, to ~4.0%, a dramatic increase in an otherwise falling rate.

• Last week, the U.S. Bureau of Economic Analysis also released an upward revised final estimate of the 2^nd quarter U.S. GDP which showed an annual growth rate of 3.0%. In comparison, the year’ first quarter had a more tepid growth rate of 1.6%. With the more robust economic growth combined with the impressive jobs report, the economy is clearly better positioned than many had believed.  

• In addition to early earnings reports from several bellwether companies, this week will also have the latest update on the nation’s Consumer Price Index (CPI) and Producer Price Index (PPI), the two most popular inflation readings. Investors are expecting both numbers to continue their gradual descent, with the CPI reading expected to have an annual 2.3% rate increase and the PPI expected to print a 1.7% increase year over year growth rate. If these numbers are achieved, the markets will happily absorb this positive data.

And the Fed finally takes action!

•The day has finally come. Fed Chair Powell announced at his press conference last week that the Federal Reserve was cutting the Federal Funds rate by 0.50 percentage points. In the days leading up to the announcement, Wall Street odds had shifted to even on whether the Fed would cut by 0.25 percentage points or by 0.50 percentage points. The market largely rewarded the decision as stocks finished the week on a strong note.

•Moving forward it is currently being projected that the Fed will cut at least one, maybe two more times by the end of the year, for a potential of 1.25 percentage points in total rate decreases.  Expectations are that these rate reductions will help ease businesses’ lending expenses, aid consumer’s inflation-stretched budgets, and potentially slow the recently climbing unemployment rate.

•One effect of the central bank raising the Fed Funds rate so high was that it created an inverted yield curve, i.e., that short term interest rates were in the unusual position of being higher than long term rates. Now, anticipating the recent rate cut to the Fed Funds rate, the yield curve has started to return to its more typical upward slope as bond maturities lengthen. With a normalized yield curve, higher yields compensate for the increased risk involved in long-term loans and the lower risks associated with short-term investments.

•Later this week, the Fed’s preferred inflation measure, the Personal Consumption Expenditures (PCE), will be released. The market is anticipating a reading of a 2.7% annualized increase – similar to the readings of the last few months. As stated previously, the market has largely deemed the battle over inflation won. Now, it is to be determined whether unemployment can stop its gradual increase over the last 12 months and if the economy can actually stick a much hoped for “soft landing.”

Attention shifting to employment data…

• Markets continue their shift in focus away from inflation data points and towards the jobs data. Last Friday, the Labor Department released its August jobs report and Wall Street was not impressed. The popular S&P 500 index closed down 1.7% and ended the week with its largest weekly loss in 18 months. The labor report showed 142,000 jobs being added in August – far below the recent monthly average of 173,000 jobs. Meanwhile, the August unemployment rate, measured at 4.2%, maintaining its relatively elevated levels.

• There are growing fears if the job data continues its recent negative trend that the economy will sail past a possible soft landing and enter into recession. Central bankers will begin meeting next week to debate on the size of their first rate cut, either a 0.25 percentage point reduction or a larger 0.50 percentage point rate cut. Two weeks ago, the odds were evenly split between a large and a small rate cut. Today, forecasts sharply favor a more modest 0.25 percentage point cut. Only the first of a series of anticipated rate cuts, next week’s reduction is predicted to be the first step of an anticipated total 2.5 percentage point decline in overnight rates over the next 18 months.

• Supporting this position was Wednesday’s Consumer Price Index (CPI) report which showed inflation coming in slightly below expectations. The reading, at 2.5%, was modestly better than the predicted 2.6% increase in prices. While not yet at the Federal Reserve’s target of 2.0%, this report highlighted inflation’s ongoing decline and re-affirmed the belief that a Fed rate cut next week is an absolute certainty. The less important Producers Price Index (PPI), an inflation report based on the supply chain, report was released this morning and showed a 0.2% increase relative to a consensus forecast of 0.1%of 1.8%-2.0%. Markets have paid little heed to this report, considering it a less important outlier.

• Taking a quick look at the political situation, former President Trump and Vice President Kamala participated in their first debate earlier this week. Going into the debate, polls were largely a dead heat between the two presidential candidates. After the debate, the perception has largely been that Vice President Harris won although the two major predictive models still suggest that the election is a tossup. Expectations are high for a proposed additional debate between the two candidates.

Times, they are a changing…

• As Fed Chair Powell announced that “the time has come for policy to adjust” at his Jackson Hole speech last Friday. Of all of Powell’s recent public statements, this is the first time he has clearly and definitively communicated the central bank’s intention to start cutting the overnight Federal Funds rate. The question now is how much will the Fed cut and how frequently? The next Fed meeting is in three weeks, current forecast predicts a 70% chance of a 0.25 percentage point rate cut and a 30% chance of 0.50 percentage point rate cut.  Before year-end, predictions are for a 76% likelihood of a 1 percentage point reduction in the overnight interest rate.  In any scenario, we believe a larger initial rate cut would be unwarranted as it would likely spook the financial markets.

• When the Fed does begin cutting the overnight borrowing rate, it will have a significant impact across the fixed income markets. Rates that affect the average consumer such as credit card debt and home equity lines of credit should all be impacted. Most importantly, mortgage rates, which are largely priced upon the 10-Year US Treasury rate, should continue their recent drop as rate expectations have moderated over the last several weeks.

• This Friday the Fed’s preferred inflation gauge, the Personal Consumption Expenditures Price Index (PCE), for July will be released. The market is largely expecting this reading to continue its recent downward trend towards the Fed’s target goal of 2%. For the vast majority of this interest rate cycle, the PCE report has been the most watched report as the Fed placed increasing focus on reeling in inflation. At this point, the battle against inflation appears to largely be won. The Fed now is turning its attention to the labor market that has seen the unemployment rate recently increase to 4.3%, up markedly from last July’s 3.5% reading.

• Not helping the Fed newfound labor market attention was the Labor Department’s report last Wednesday which had surprising downward revision of 818,000 jobs created over the twelve months prior to March. Instead of adding on average 246,000 jobs a month, the U.S. economy added only 178,000 a month, or 28% fewer positions than had originally been believed. While economists had expected a downward revision, the revisions magnitude was unexpectedly large. Interestingly enough, the market took this news in stride and ended the day in the green.

A tumultuous stretch as the markets eagerly look towards an initial rate cut…

• In early August, the broader stock market collapsed almost 7% in a matter of days on the back of July’s weak jobs report and the unwinding of the yen “carry trade.” Non-farm payrolls came in sharply beneath expectations at 114k as opposed to the forecast of 190K. Additionally, the U.S.’s unemployment climbed to 4.3%, and above the market’s expectations. Exacerbating the issue was trader’s efforts to unwind previously cheap borrowings in Japan as the yen climbed sharply relative to the US dollar following an unexpected rate increase by the Bank of Japan.

• In subsequent days, the market largely recovered these recent losses as concerns over economic growth abated. Correspondingly, the market’s volatility index, which had soared by more than 100% amidst the market’s sharp decline, slid back to prior levels in subsequent days as the market recovered most of its losses.

• Based on the most recent data, expectations are strongly fixed upon a central bank rate cut following their September meeting.  Today’s Consumer Price Index release showed continued cooling with a 2.9% overall year-over-year price increase for July -providing further support to the thesis that inflation is sufficiently moderating and keeping the Federal Reserve teed up for an initial interest rate cut in September. Beating expectations of 3% and printing a sub 3% annual rate for the first time since March 2021, the data release provides evidence that the fight against inflation is succeeding.

• However, in an attempt to dampen expectations, recent comments from Fed leadership have echoed Chair Powell’s prior messaging that the Federal Reserve will remain data dependent on potential rate cuts and, therefore, that a September rate cut is not yet assured. Conversely, there are increasing fears that the central bank’s reluctance to cut rates may already have set the economy on an inescapable path to recession.

Will it soon be time to take action?

• Today is Fed Day, the day that the Federal Open Market Committee (FOMC) releases its update on its interest rate outlook. Earlier this afternoon, officials moved closer to lowering interest rates from their two-decade high by signaling the likelihood of a September rate cut.  The US central bank’s Federal Open Market kept its benchmark rate in a range of 5.25% to 5.5%, a peak reached a year ago, at the conclusion of its two-day policy meeting. Policymakers acknowledged that inflation has made progress toward their 2% goal — a prerequisite for rate cuts — following tame readings on consumer prices for the month of June. With unemployment also edging higher, officials indicated it’s appropriate for policy to become less tight soon. However, even if there is a September rate cut, it does not mean that other actions will immediately follow suit.

• As for the markets, the Mega Cap tech stocks have had a tumultuous month having sustained losses in excess of $1.5 trillion before recovering in recent days. Alphabet, the parent company of Google and YouTube, reported a slowing of sales while Tesla announced that its profitability took a hit due to a reduction of revenue as well. Microsoft meanwhile has modestly sold off today as it reported a massive increase in capital outlays. However, a positive outlook from chip stock Advanced Micro Devices (AMD) has spurred a broad tech rally with Nvidia rising by almost 12% today and dragging along most tech players with it. Notwithstanding AMD’s upbeat outlook, reported results in the tech sector have largely been beneath expectations.

• Recent readings on the job openings came in above forecast last month with also May’s reading being revised higher – defying the recent softening in the labor market. Available positions, known as JOLTS, edged lower to 8.18 million on Tuesday, exceeding most estimates. The reports showed that solid demand remains for workers even as unemployment rose for a third straight month in June. Meanwhile, the number of vacancies per unemployed worker, a closely watched ratio by the Fed, held steady at 1.2 – and in line with levels seen prior to the pandemic. However, appreciable concerns have arisen regarding the accuracy of the JOLTS and vacancies per worker data as response rates to the government surveys have declined severely over the last several years.

• On the political front, uncertainty remains with the presidential election less than 100 days away. The week after Trump’s assassination attempt, it appeared as though former President Trump was on his way to a landslide victory. However, with President Biden dropping out of the race and Vice President Harris stepping in, the Democratic party has fervently gathered behind the current VP. Most polling now shows the race to be a dead heat. It is unclear whether this polling bounce is just a honeymoon period for Harris and the Democrats or whether it will be sustained. For the time being, substantial uncertainty exists regarding the likely outcome of the Fall elections.

No recent love for the Magnificent Seven…

• Following the horrific assassination attempt on a former President, polling data is now strongly predicting a second Trump Administration. Meanwhile, President Biden is facing continued pressure to step down from the Democratic ticket for the upcoming election. Markets have been digesting the forecast of another Trump presidency by determining how to be positioned and act towards the now anticipated high tariff and more inflationary environment that is likely to result.

• In the meantime, current inflation readings continue to abate as seen by the recent Consumer Price Index (CPI), a figure released last week.  June’s CPI declined with a 12-month rate of 3.0%, the lowest annual increase in three years whereas the Producer Price Index (PPI) reading was less positive with a 12-month rate increase of 2.6% – the largest annual increase since March of 2023. However, the U.S. consumer continues to spend though as retail sales remained flat year-over-year as opposed to expectations of a decline.

• Meanwhile, Fed Chair Powell made a major public appearance at the Economic Club of Washington on Monday. Despite recent inflation data continuing to trend lower, Powell’s public was unchanged with him stating that “I’m not going to be sending any signals one way or the other on any particular meetings.” Further, Chair Powell expressed his belief that the economy is heading for an economic soft-landing and that a “hard landing” did not seem likely at this point.

• The equity markets have had an appreciable rotation in recent days with mega-cap tech stocks experiencing recent declines. Surging forward have been small cap stocks with five days of consecutive gains and a 3.5% gain on Tuesday.  This is however a positive sign that the stock market rally is broadening to other parts of the market and showing investors’ confidence in the American economy.