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On September 16, 2024
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[1]
U.S. Federal Reserve - A Close Call
We cannot rule out a 50 bps move this week and believe the decision will be highly debated within the Federal Open Market Committee. By Seema Shah, Chief Global Strategist The Federal Reserve (Fed) will begin its rate cutting cycle this Wednesday. Market expectations are split between a 25 basis point and a 50 basis point rate cut, as the decision is complicated by conflicting signals of solid economic activity but a weakening labor market. Rarely have market expectations been so torn, so close to a FOMC meeting. Our own forecast has been for the Fed to cut policy rates three times this year - 25 bps at each of its September, November and December meetings. However, we cannot rule out a 50 bps move this week and believe the decision will be highly debated within the Federal Open Market Committee. Why 50 bps is potentially in play There are three key reasons for the Fed to be actively considering a 50 basis points cut: Inflation: For the Fed, it comes down to deciding which is a more significant risk - reigniting inflation pressures if they cut by 50 bps, or threatening recession if they cut by just 25 bps. However, inflation numbers have improved meaningfully in recent months, with monthly core PCE inflation averaging just 0.1% for the past three months, down from 0.4% in 1Q 2024, and the annual rate now down to just 2.7%. With inflation seemingly contained, the Fed should be able to focus on the labor side of its dual mandate and frontload rate cuts to insure against recession. Credibility: Having already been criticized for responding to the inflation crisis too slowly, the Fed will likely be wary of being reactive, rather than proactive, to the risk of recession. Market reaction: Historically, a 50 bps Fed cut has prompted major market angst as investors question what the Fed knows about the depth of economic weakness that they don't. However, market moves in the past three to four weeks, following the surprisingly weak July jobs report, suggest that the market may, in fact, react more negatively if the Fed only cuts by 25 bps versus 50 bps. On the days that market expectations have priced in a higher probability of a 50 bps cut, the broad market has risen, led by small-cap stocks and cyclicals. By contrast, on the days where a 25 bps move looks more likely, the opposite has happened. As a result, the Fed may have less to fear about a 50 bps cut than it typically does. Yet, history is on the 25 bps side While these are perhaps convincing reasons, historic Fed cutting cycles suggest a 50 bps cut would be unusual. Since the late 1980s, when Fed policy shifted away from large swings in policy rates and became more stable and credible, 25 bps cuts have become the norm, and 50 bps have been the exception. There have only been two Fed rate cutting cycles that began with cuts greater than 25 bps in magnitude: January 2001 (bursting of the dot-com bubble) and September 2007 (sub-prime mortgage collapse). Both of those periods stood out from the rest, characterized by concerns around severe asset price bubbles and financial systemic risk. While there are some vulnerabilities in the current cycle, global financial stability risks have receded. And while there have been concerns around a tech bubble, the fundamental productivity gains from AI, and strong earnings delivery from large tech firms, indicate that tech valuations are not as stretched as they were in the dot-com boom. Looking beyond the 25 bps vs. 50 bps decision Wednesday's FOMC decision is a toss-up. Without an asset price bubble or systemic risk, a large cut is likely unnecessary. Yet, there is arguably nothing to lose by opting for a 50 bps cut, other than setting a precedent for future cutting cycles. Ultimately, though, the 25 bps vs. 50 bps decision is less important than the fact that Wednesday will mark the beginning of the cutting cycle, with the Fed likely signaling that a string of rate cuts is in the pipeline. Although the U.S. labor market is clearly slowing, the continued strength of household and corporate balance sheets suggests that there is nothing so broken about the U.S. economy that a sequence of Fed cuts cannot fix. Risks around the FOMC forecast are elevated, but recession risk remains low. Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. The Principal Financial Group (The Principal®) is a global investment management leader offering retirement services, insurance solutions and asset management. The Principal offers businesses, individuals and institutional clients a wide range of financial products and services, including retirement, asset management and insurance through its diverse family of financial services companies. Founded in 1879 and a member of the FORTUNE 500®, the Principal Financial Group has $519.3 billion in assets under management1 and serves some 19.7 million customers worldwide from offices in Asia, Australia, Europe, Latin America and the United States. Principal Financial Group, Inc. is traded on the New York Stock Exchange under the ticker symbol PFG. For more information, visit www.principal.com. Insurance products issued by Principal National Life Insurance Co (except in NY) and Principal Life Insurance Co. Plan administrative services offered by Principal Life. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Princor Financial Services Corp., 800/247-1737, Member SIPC and/or independent broker/dealers. Principal National, Principal Life, Principal Funds Distributor, Inc. and Princor® are members of the Principal Financial Group®, Des Moines, IA 50392. Investing involves market risk, including possible loss of principal.
[2]
Starting The Tight Policy Unwind
The Fed policy meeting takes center stage this week. The recent drop in U.S. core CPI stalled in August, likely taking a 50-basis-point cut off the table, in our view. The Federal Reserve is set to cut interest rates for the first time since the pandemic. Yet it and other central banks are not heading for an easy policy stance. 1) Why we don't see recession ahead An uptick in the unemployment rate has helped stoke recession fears. We see these fears as overdone. Employment is still growing robustly. The unemployment rate is not rising due to layoffs, but because elevated immigration has expanded the workforce. 2) Recession pricing overdone Markets are pricing Fed rate cuts as deep as those in past recessions. We think this is similarly overdone. Once immigration normalizes, the economy will not be able to add jobs as quickly as it has been without stoking inflation. This will keep the Fed from cutting as deep as in past cycles, we think. 3) ECB policy The European Central Bank cut rates again last week. We see euro area inflation falling to 2% and staying near there - giving the ECB more room than the Fed to cut rates. Yet supply constraints make it unlikely inflation will go back to being well below 2% like it was before the pandemic. We see the ECB holding rates well above pre-pandemic levels. Short-term U.S. Treasury yields have slid on expectations for deep Fed rate cuts, so we went underweight. We're neutral euro area government bonds and UK gilts as market pricing of rate cuts is more aligned with our view or can go further. The Federal Reserve is set to start rate cuts this week after its rapid hikes to rein in inflation. Markets expect the Fed to cut rates sharply - and we think this pricing is overdone. U.S. inflation has slowed as pandemic disruptions have faded and due to a temporary immigration boost to the workforce. We see inflation staying sticky due to loose fiscal policy and the impact of mega forces, limiting how far the Fed can cut. Yet, we think recession fears are overdone and stay overweight U.S. stocks. No recession response required Fed rate cuts in response to previous recessions and current pricing Markets have been quick to price in rate cuts after the Fed finished its fastest hikes since the 1980s - and price them out when inflation spooked to the upside. As the Fed readies to start cutting, markets are pricing in cuts as deep as those in past recessions. See the chart. We think such expectations are overdone. An uptick in the unemployment rate has stoked recession fears, yet employment is still growing. The unemployment rate is not rising due to layoffs, but because elevated immigration has expanded the workforce. Consumer spending shifting back to services from goods after the pandemic has helped inflation fall from its recent highs, allowing the Fed to cut rates. A larger workforce is helping cool services inflation. Yet in this new regime, central banks face a sharper trade-off between curbing inflation and protecting growth than in the decades-long period of steady growth and inflation. Cooling inflation is likely temporary. The post-pandemic normalization of spending and supply mismatches is largely over, while immigration is likely to fall back to historic trends. Once it does, the economy won't be able to add jobs as fast as it has been without stoking inflation. Wage growth has slowed, but not enough to suggest that core inflation could fall to the 2% target. Supply constraints from mega forces, or structural shifts, are set to add to global inflation pressures. That's why the Fed and other central banks will keep rates higher for longer. Yet short-term U.S. Treasury yields have slid on expectations for deep rate cuts, so we went underweight. We stay overweight U.S. stocks but broaden our artificial intelligence view beyond tech. Our Midyear Outlook scenarios acknowledge the low odds of the Fed cutting rates as much as markets expect. That could occur if the Fed sees cooling job growth as a sign it's been too slow to react to worsening growth, echoing its rapid rate hikes. Risk sentiment may sour once it's clear the Fed won't cut rates as low as markets expect. The European Central Bank (ECB) cut rates again last week, even as inflation is above its target for now. We see euro area inflation falling to 2% and staying near there, unlike in the U.S. That's still far from the low inflation of the past decade. But the ECB tightened policy more than the Fed - even as it faced weaker economic activity - so it has more room to cut rates, in our view. We're neutral euro area government bonds and UK gilts as market pricing of rate cuts could go further, in our view. The People's Bank of China has been cutting rates, but it's not in the same boat as the Fed. It's facing weak consumer demand, excess production capacity and deflation - based on broad measures of inflation - that could become entrenched. The lack of fiscal and other policy support casts doubt on if the economy will hit this year's growth target. Export activity has been supporting growth, so it will be key to watch for any signs of weakness. Chinese equity valuations are low relative to other regions but given the tough macro outlook, we prefer developed market equities over emerging markets and China. The Fed is following in the footsteps of other central banks to cut rates this week. We see sticky inflation limiting how far central banks can cut. We stay overweight U.S. equities and prefer European over U.S. bonds. U.S. stocks rose about 4% last week, rebounding from their largest weekly drop in 18 months, with tech helping lead the way as recession fears faded and on coming Fed rate cuts. U.S. 10-year Treasury yields touched 15-month lows, settling near 3.66% with markets pricing in 200 basis points of Fed cuts by next June. We think this is overdone and could set up more sharp pricing shifts as markets see-saw between starkly different potential outcomes. Central bank policy meetings take center stage this week, headlined by the Fed. We expect the Fed to cut rates for the first time since its rapid hikes launched in 2022. Yet, the recent drop in U.S. core CPI stalled in August, likely taking a 50-basis-point cut off the table, in our view. The BOJ will also be in focus after being a source of market volatility after its last meeting in late July.
[3]
Market Implications Of A Fed Interest Rate Cut
With a Fed rate cut expected this week, the debate is whether the Fed cuts 25 basis points or 50 basis points. A large portion of the market's large cap return this year has been driven by the performance of the Magnificent Seven stocks. Not uncommon in September and October is elevated market volatility, with third quarter-to-date returns being volatile from week to week. As the third quarter is nearing an end, though, a broadening of stock participation is occurring in the market. As the below chart shows, some of the best-performing areas in the market on a quarter-to-date basis are the dividend payers. Out of the six categories shown in the below chart, the four best performers are the dividend-paying strategies and the equal-weighted S&P 500 Index (RSP). The worst-performing category is the Magnificent Seven (MAGS) stocks. With a Fed rate cut expected this week, the debate is whether the Fed cuts 25 basis points or 50 basis points. The equity market tends to do well following a cut, so long as the economy is not in a recession. Various versions of the below chart have been highlighted recently by strategists, but the chart does show historically the S&P 500 Index does well after rate cuts so long as the economy is not in a recession. At this point in time, the economy's growth appears to be simply slowing to a pre-pandemic growth rate. Also, important are what areas or sectors of the market perform better after the rate cut. The below chart from a recent iCapital report shows Consumer Discretionary, Information Technology and the Materials sectors tend to be laggards following rate cuts. The stronger-performing sectors historically are Health Care, Consumer Staples, Financials and Energy. This sector rotation is supportive of potentially more rotation away from the Magnificent Seven stocks. Granted, the artificial intelligence (A.I.) theme driving the strength of some stocks benefiting from this business does not seem to be going away, but prices for some A.I.-related stocks may have gotten ahead of themselves near term. A segment of the market benefiting directly from interest rate cuts is the bond market, since bond prices rise as rates decline. The 2-year U.S. Treasury yield has fallen from over 5% at the beginning of May to under 3.6% now. A large part of the bond return benefit may have already occurred as investors anticipated the cuts likely occurring this week. This decline has served as a tailwind for bond returns, as seen in the below chart. This anticipation can be seen in the flow of investment dollars into mutual funds and ETFs. On a year-to-date basis fund flows into bond funds and ETFs equal $294.7 billion while domestic equity flows equal $68.7 billion. This week might see elevated market volatility due to the Fed rate decision coming on Wednesday as well as it being a triple witching week for options. Then, throwing in all the potential election rhetoric, it is incumbent that investors focus attention on their longer-term investment goals and not the day-to-day noise. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
[4]
The Fed Preview: Let The Easing Cycle Begin - A 25bpt Cut And The Market Selloff Likely
A policy normalization with a soft landing might not be possible, as only a recession can restore price stability, given the immigration dynamics. The Fed is set to start a monetary policy easing cycle on Wednesday at the September FOMC meeting. The CME Federal Funds futures are indicating a 50% probability that the first cut will be a jumbo 50bpt cut, with a 50% probability of a 25bpt cut. For the traders this is a 50-50 bet, like a flip of a coin. The bet seems to be that the stock market could rise sharply with the 50bpt cut, but fall in disappointment with a 25bpt cut. But before digging into the analysis, let's establish chronology of the events leading to the first cut. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks. So, let's look at the data, and start with the labor market. In fact, this is exactly what the FOMC will do at the meeting before making the decision. The job creation, based on the non-farm payrolls, has been slowing since March 2024 (the blue line). At the same time, the pace of layoffs has been increasing, based on the 4-week average in weekly claims for unemployment (the red line). However, the non-farm payrolls for August were higher than in July, while the weekly clams have been falling for 6 weeks, so the labor market is not deteriorating, and we are not in a recession-type environment yet where the Fed needs to cut aggressively. In addition, the weekly claims are still at a very low level historically, which suggests that the labor market is still tight. Still, the trend of weakening in the labor market is firmly in place, which suggests that the Fed is likely to proactively cut by 25bpt next week. The Fed Chair Powell revealed in Jackson Hole that the main worry for the Fed was the inflationary wage-price spiral - where higher wages lead to higher prices, which lead to even higher wages, and so on. However, it looks that this worry has eased, based on Powell's Jackson Hole speech. It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. Thus, the Fed now feels confident that inflation will sustainably fall to the 2% target, and thus, can start easing the policy rate. In support, the monthly inflation has been cooling over the summer, pushing the quarterly annualized inflation to 2% already. However, the 3-month streak of the low monthly core CPI inflation readings at 0.1-0.2% was broken in August with a 0.3% core CPI reading. That's too high - it's equivalent to 3.6% annual inflation if it continues at this pace. In fact, the Fed's InflationNowcast is predicting a core CPI at 0.27% (rounded to 0.3%) in September as well. So, this would not be a positive development for inflation. The main driver of inflation is Shelter, which rose by 0.5% MoM in August. The main driver of Shelter inflation is the housing shortage, which is exacerbated by high immigration. Immigration is boosting the labor force, and thus it's easing the labor shortage - and that's good for inflation because it's keeping the wage growth in check. At the same time, immigration is exacerbating the housing shortage, and potentially pushing the shelter inflation higher. In order to lower Shelter inflation, the supply of housing needs to increase, which requires more construction workers, and thus more immigration. This is the new vicious cycle likely to keep inflation elevated above the 2% target. The point is that the problem with inflation is now solved. Thus, the 0.3% core CPI print for August is essentially ruling out the 50bpt cut at the September meeting, which concurs with the data from the labor market. Looking back at the 50-50 coin toss bet - my prediction is that there is a 100% probability that the Fed will cut by 25bpt next week, and that's supported with the analysis of the recent labor market and inflation data. Thus, if the short-term bet is that a 25bpt cut will disappoint the market, and consequently that the S&P500 (SP500) will sell off on the news, that's the bet that I would take. However, short-term trading is risky, and anything could happen. The real question is what are the longer-term implications. The aggressive monetary policy easing expectations embedded in the bond market are generally associated with a recession - and that means that the stock market is facing a recessionary bear market. That's my baseline scenario. On the other hand, the bond market could be pricing a policy normalization, where the Fed lowers the interest rates to the neutral level, and that could be positive for the stock market because it assumes a soft-landing (no recession). But what is the r* or the neutral rate? It could be much higher than 3%. In fact, the current policy rate might not be restrictive at all. Even the Fed (Kansas City) thinks that the current policy rate is not sufficiently restrictive. The truth is nobody knows what happens next, partially because we don't know who will be the next President of the United States, and we don't know what the immigration policy will be, among many other key issues such as taxation and trade policy. Either way, the current environment is inflationary, given the unfolding trend of accelerated de-globalization. There is an oil tanker on fire in Red Sea as I write this. Powell referenced the war in Ukraine as one of the reasons for high inflation in 2022 - and that war is still raging with no end in sight, and other wars are progressing. New tariffs on China are being erected. The project of aging population replacement with immigration in the US and Europe could backfire in so many ways, first with higher shelter costs, and ultimately with domestic political instability. The stock market has very strong momentum and wants to go higher, and the risk is to the upside as long as the data does not clearly indicate a recession, at which point the bubble would burst. But this is not the environment to chase the market, it's the environment to reduce the exposure to the stock market, especially for anybody getting close to retirement. The risk is still that the Fed's likely cut could be premature, and result in higher inflation, as we saw in August CPI numbers. But also, the risk is that we could already be slipping into a recession, based on higher consumer delinquency rates, and other indicators. In addition, there is a bursting Gen AI bubble, as the Gen AI hype is fading. Further, the risks associated with the US election and the geopolitical escalations are only rising. This is all happening with the S&P500 (SPY) (SPX) trading at the PE ratio of 24.
[5]
Finally, It's Time To Cut Rates
Looking for a helping hand in the market? Members of The Financial Prophet get exclusive ideas and guidance to navigate any climate. Learn More " I wrote about the inflation report that moved markets last week, and now, all eyes are on the Fed. Typically, the Fed cuts rates when there is a problem or when something is seriously wrong with the economy. Therefore, lowering interest rates is often associated with negative economic factors and potential downside for stocks. However, the economy remains resilient, and the Fed will likely cut rates on September 18th. We've been trapped in a relatively high interest rate environment for a long time. Now that inflation has decreased considerably and the job market has weakened, it's time to cut rates. Moreover, housing, manufacturing, and other segments of the economy are showing signs of substantial weakness. While the near-term volatility could persist, a more accessible monetary stance should lead to improved growth and increased liquidity, a highly constructive dynamic for high-quality stocks and other risk assets. Furthermore, the Fed could cut by 50 Bps to kick things off, which markets should welcome. Also, corporate earnings remain healthy, and despite the potential temporary growth slowdown in AI and other segments, we could see improving and better-than-expected earnings in future quarters. Valuations, while elevated, are not nearing any extremes, implying there could be substantial upside in the current bull market. Due to this constructive dynamic, I am keeping my S&P 500 "SPX" (SP500) year-end target at 6,200. "There are no such things as triple tops." That's how the trading saying goes. Incidentally, we see the SPX approaching what could be a triple top, but there is a high probability that the SPX will break out. We witnessed a highly constructive technical correction in July and early August. This correction lowered the SPX by about 10% to roughly the 5,200 support level. Moreover, the SPX successfully re-tested the support, only dropping to 5,400 recently. Now, SPX appears set up for another move higher here. While there are several crucial data points this week, it's all about the FOMC and the rate cut. The million-dollar question, of course, is, will the Fed cut by a modest 25 Bps or go big with a 50 Bps jump cut? The market would very likely react more favorably to the more significant 50 Bps cut. However, the essential element is that the Fed is on the right path to a more accessible monetary environment. Therefore, while we may see an adverse knee-jerk reaction to a 25 Bps cut, the selling will likely be short-lived, and a post-FOMC pullback will likely turn into a buying opportunity in the coming days. Rates will likely be much lower by early next year. There is about an 80% probability that the funds rate will be around 3.75-4% or lower by the end of January 2025. This is a vast difference from the current 5.25-5.5% benchmark rate environment. Therefore, we could see about 150-200 Bps worth of cuts in the next several months. I want everyone to realize how significant the initial rate reduction phase could be. The Fed may take a shock-and-awe approach, including potential jumbo 50 Bps cuts in the mix as it moves toward an appropriate rate policy. Also, 4% is not the floor. Instead, it's likely only the beginning. The benchmark could be around 3% by around mid-year 2025, and we could see lower interest rates after that. It seems like every time the Fed embarks on an easing cycle expectations are that it may end half way right after things normalize. In reality, monetary cycles typically don't stop half or part of the way. They go "all the way." The Fed may tolerate higher inflation to increase growth and improve the labor market. Also, inflation could have a lagging effect and continue lower even as the Fed transitions to a lower interest rate policy. Inflation could also increase gradually as growth may be sluggish in the near future. Thus, we could see much more easing and potential future QE and other stimulus programs, providing backstops and liquidity to markets in the coming years. It seems like earnings just ended. Nonetheless, earnings season approaches again. The recent earnings season was primarily positive, and much of the guidance was also solid. Therefore, we could see outperformance when big reports start in early October. Big banks, including JPMorgan (JPM) will report on October 11th, and we should see many bellwether stocks reporting around this time frame. This dynamic creates a favorable catalyst for stocks to move higher into the best time of the year, the holiday season, and year-end. The S&P 500 trades at a forward P/E ratio (non-GAAP) of approximately 22-23. While this may seem relatively expensive historically, it may be inexpensive in the context of entering an easing monetary cycle in a resilient and stable economic atmosphere. Also, the growth image can improve, and earnings may increase more than expected, implying that the forward (2025) P/E ratio may be below 22 here. Also, the Nasdaq 100's forward P/E ratio is around 29, but it may be around 28 or lower relative to 2025's earnings, which is a slightly more bullish case outcome. Considering the AI growth potential and upcoming monetary environment,28-30 times forward earnings may not be too expensive for the world's best tech companies. The S&P 500's Shiller P/E ratio is around 36 now. While historically, this is relatively high, the all-time high was around 44. Also, the Shiller P/E ratio could move to an ATH in this bull market cycle. This dynamic implies that earnings, valuations, and stock prices could continue to appreciate from here. Due to the solid technical and fundamental dynamic, I am leaving my SPX year-end target at 6,200.
[6]
Expect A .25% Cut And A Cautious Fed Statement, Buy The Dip
Lower interest rates will benefit mortgage originators, select banks, insurance companies, and cyclical industries; focus on businesses that thrive with lower credit costs. Expect A .25% Cut, and a Cautious Fed Statement, Buy The Dip Market participants have been traveling a well-worn path for 2 years. Every time there was some discussion about cutting interest rates, the speculative chatter would swell the possibilities to outsized proportions. Only later to be disappointed when lanced by reality. The reality in this case is that demand could reignite inflation. Talk of at least 100 basis points from now until the end of the year, and then perhaps 100 BPs rapidly in 2025 is just too far. Do we really think Powell will risk unleashing a tremendous amount of money supply in such a short period? The last thing Powell wants is to reignite inflation. This is likely your first question, it would be mine. The lower the FFR, the lower the other rates of bonds of longer maturity become. Already the 10-Y has a 3-handle on it, I suspect that once the Fed cuts rates the 10-Y will firm up a bit, especially if, as I believe, the Fed cuts by .25%. However, if the Fed cuts by .50% I think that will cause a rush into the long end because the Fed is signaling aggressive cutting. That will further pressure mortgage rates, this week I saw the 30-year fixed rate as low as 6.15%. It would be very plausible to see a 5-handle on rates with an aggressive Fed. That in turn would unleash a flood of Refinancing, putting a lot of cash in the hands of consumers. Also, with the lower FFR and a normalized rate curve, we could see more lending of regional banks who have been starving for better NIM - Net Interest Margin. More bank lending increases the money supply as well. The simple definition of inflation is too much money demanding not enough goods. More money supply, more inflation. The S&P 500 gained 4% this week, reversing the bad performance at the start of the month. The 500 stock index closed at 5626, just 40 points shy of the all-time high. Furthermore, the current average PE is 27.80, which is quite fully valued. Of course, the Super 6, or Magnificent 7, or Super 8, however you want to organize the biggest market cap growth stocks are pulling up the current PE. I agree, but the biggest, best growth stocks have always pulled up the average PE. Valuation is a very poor timing mechanism, and I would only cite it because we are coming to a very important new piece of data. There are a lot of unknowns going into this decision, will a 25% rate cut disappoint the market? If Powell gives a buoyant projection of rate cuts, ones that won't be interrupted by new macro data that show a jump in inflation potential? Then great, I think the stock market does fly, and long rates drop even further. If Powell cuts by 50% but gives a more dour forward guidance, then I think the market sells off. Though I expect a .25%, it is how Powell presents the cut that is really the important event on the 18th. It seemed a settled notion that the Fed was going to cut .25% given the fairly strong economic numbers of the last week or so. In the last half of the week, there was more chatter that there would be a .50% cut. There is a very good chance that a .50% cut could roil the market, with the question of what does the Fed know that we don't? Therefore, if there is a .50% cut, Powell would like to explain away an aggressive cutting cycle and remain conservative. Again, I believe that no matter what, Powell should stress that the cutting will be very gradual. The rationale for cutting is that the "real rate" -- the current interest rate minus the rate of inflation, is too high. I maintain that no one really knows what the "real interest rate" is. Otherwise, we'd have been in recession long ago. Don't let us forget the countless wise men and women who made the pronouncement that a recession was around the corner. Yet, a recession did not come. Though, there were many excuses, like the free money that was handed out. Sure, that helped, but that money has long been spent. The real reason the economy did not falter was that the demand for jobs was enormous. Also, we had a huge influx of workers that helped grow the economy even with higher interest rates. Now the higher rates have finally gained traction and the economy is slowing somewhat. The very thing that is spooking the market at times is what we were hoping would happen. Fewer jobs, and fewer job openings, and it is a tad harder to get a new job. Also, a very good and unexpected thing is higher productivity. High productivity might also temporarily lower demand for workers, so it might not even be the higher rates as the sole reason for greater job scarcity. When I say job scarcity, there are still more job openings than there are jobs, just not as many. According to the Federal Reserve Data - FRED, there are 1.2 openings per available worker. So while we are witnessing an unemployment percentage that is creeping up, there are still enough jobs out there. That doesn't mean it was as easy as before. It also means that employers can be a lot more demanding about education and experience. I feel sorry for college graduates who majored in Anthropology or other liberal arts degrees. They may end up getting some training in AI development or some such skills to get a job. I don't believe Powell is that concerned about the unemployment percentage at 4.3 or even if it rises to 4.5% these are still great unemployment numbers. The concept of full employment used to be at 6% in the US. What Powell doesn't want to see is that by June of 2025, inflation starts to go up with all this additional money that has been put in the pockets of the home-owning middle class. These are the ones that are still spending on experiences, and dining out. Now with lower mortgage payments after refinancing or some getting HELOCs - Home Equity Line of Credit to spend on new goodies. Also, even without an increased money supply than we already have, The Atlanta Fed GDPNow estimate is 2.5%. That is in no way signaling a recession, so why go .50% and throw caution to the wind with a dovish-cutting regime? It makes absolutely no sense. I have been harping on the notion of a sell-off for a few weeks, for the latter half of September, and here we are. So, does that mean you sell everything on Monday morning? At this point, if you wanted to be cautious you'd have some cash ready in your trading account, and long-time readers should by now remember that I have been saving up my investment allocation for this Fall hoping to collect some stocks on sale. If I am wrong and Powell does come in like a dove, then maybe he truly knows something that we don't know. Warren Buffett has been selling a lot of stock in Apple (AAPL), and Bank of America (BAC). Ajit Jain, Berkshire Hathaway's top man, has sold half of his Berkshire Hathaway (BRK.A) stock. I usually don't make a thing about stock selling; it just seems odd timing. Especially since Ajit is one of the people named to take over when Mr. Buffett retires. Anyway, it's easy to be a bearish writer, but not that easy to be a bearish investor or trader, especially a trader. If we do end up rallying, then there is the November presidential election that normally has some kind of October surprise, though Biden leaving the race might have been October come early. If I am correct, Powell doesn't go completely into the dovish camp and confirms 100 BPs of cuts. Then he has to take a measured approach to cutting. The economy is still growing nicely, but it makes sense to loosen things up because inflation is under control, so .25% now and a few .25% cuts in the future. I do expect a sell-off with that news, but it could be mild. The real selling could come on any news that references a slowing economy, even though it is the only way the Fed can fight inflation, keeping rates on the high side even as they slowly lower them. On the other hand, a fully valued market selling-off may result in losing all the gains of last week. A 4% retreat in the offing might cause some selling in the next 3 trading days as well. The easy answer is to maintain some hedges going into the next few days. I added to my hedges on Friday, but I also sold some positions to have cash ready, to pick up some names that would likely be used as a source of funds. If you guess the technology stocks, you would be correct. The Tech Titans outperformed the market to the upside last week. In my opinion, I want to note that big-cap tech was once seen as a safe haven in times of instability, most of this year. We haven't seen that lately because in a lower interest rate environment, other stocks can go up as well. So I expect these high growth big cap names to give up their gains. NVIDIA (NVDA) gained about 20 points last week, if it gives those 20 points back up, I would be inclined to pick some NVDA. I have seen an interesting pattern with Micron (MU) though it isn't a big-cap tech name, it trades with NVDA. Bank Paribas gave MU a double downgrade, the stock fell in the morning on Thursday and I got in for a trade, closing it on Friday up 25%. If the market sells off as I expect, I might trade it again. I think Alphabet (GOOGL) put in a bottom this week with all the legal concerns, so if GOOGL falls back to that bottom of this week. I think it could be a nice trade. As far as investing is concerned, I want to share a direction rather than specifics. Lowering rates is going to be a real trend for the next 18 months. Think about what businesses would benefit from lower rates. I pointed to a Refi trend, so companies that originate mortgages should do well. Select banks should do well as the yield curve normalizes; they can make small business loans and mortgages since Money Market Funds will be going lower and their margins will rise. Insurance companies have already been doing great, with borrowing costs lower they could leverage more returns. Cyclical industries should be doing a lot better, and money to spend on consumer services should continue to do well. I am sharing an interest rate strategy paper with my investment group. It's hard to focus just purely on the stocks that will appreciate because business is better at lower rates. The truth is, all businesses do better when credit is at a more reasonable level. Right now, I am hedging using Puts on the 3X S&P 500 (SPXL) and the 3X Nasdaq-100 (TQQQ). I am long Rocket Companies (RKT) for the Refi concept, I have an expiration all the way out to March, so I can wait. I am also long Rubrik (RBRK), their IPO lock-up expired this past week and I think it should have a nice bounce back. I have that expiration out to April, so I can wait for it to reach back to old highs. Finally, I am Long Viking Therapeutics (VKTX) based on the progress of their GLP-1 including a pill version. I think one of the big pharma names will wise up and pay up for it. I have a long-term investment in it. I made my first purchase for $17 a share, and my average cost basis is $30. The current market cap is about $7.5B. I think it's worth 3 times that to the right buyer. Even as it continues progressing, I think the stock should continue to move back to its old high of 99. Of course, this is just me thinking out loud. Best of luck to everyone. If I am wrong and the market rallies after the cut, please be careful anyway, hold some cash. As you trade, set aside your winnings to cash. September is still September.
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Weekly Market Pulse: What Will The Fed Do?
Simple rules of thumb - like the Sahm Rule or the LEI or the yield curve - are not going to cut it in this economy. It's Fed week again, when the monetary mandarins gather to set interest rates and guide the economy according to the latest 3-year plan (central planning may not have worked for the communists, but our people are smarter). This is a quarterly meeting when they'll sift through the tea leaves or gaze into their crystal balls or whatever they do to produce their Summary of Economic Projections, which based on its past accuracy probably shouldn't be capitalized. These estimates of future growth, inflation, and unemployment are intended, as best I can tell, to prove that economists were invented to make palm readers look good. I'm sure the seers (economists) at the Fed have some really intricate, complex models to help them with this exercise, but it always looks to me like they just took the averages of the recent economic data and put future dates on it. So, let me save you some time and tell you, in advance, what they'll say in the SEP. They will predict that real GDP will grow around 2% for the next three years or so, which is right about average since 2010. They will predict that inflation will fall steadily back to 2%, because...well because that's their target and of course they'll hit it, the only question being when. In the June SEP, they thought that would take until 2026 which only seems like a long time if you have to, you know, buy things. They will predict that unemployment will be about 4% for the next couple of years because that's what it's been lately. Some of their new guesses will be different from their last guesses, by a tenth of a percent or two, and pundits all over will declare it the most significant change since the last time they made a change. The big question in the investment world last week was whether the Fed would cut the Funds rate by 25 or 50 basis points, as if the only thing standing between us and recession is a 1/4% change in the interbank overnight lending rate, even though no banks are actually borrowing from or lending to other banks overnight. Of course, if they go for 50 it could be a signal from the Fed about how bad things really are because you know they know things we don't. Yeah, no. The Fed isn't hiding anything about the economy, and even if they had data we don't - which they don't - they sure haven't made very good use of it in the past. That doesn't mean the market won't react to whatever the Fed does and whatever Jerome Powell says in the press conference, because it most assuredly will. The market raised expectations for a 50 basis point cut last week, and if the Fed goes 25, some people are going to sell stocks because they think it makes a difference. I assure you it doesn't. If we get a recession sometime soon, it won't be because the Fed only cut 25 instead of 50. The SEP and Powell's remarks will be pored over for clues about future changes in monetary policy, and some investors will make big decisions based on their interpretation of the words and figures handed down from on high. Well, for about a day or two anyway, until some other important data diverts their attention, or they forget about the economy altogether because Artificial Intelligence is going to change the world this week or surely by next month. Or maybe the punditry will move on to the election and how that might change the economy and markets, not just right now but for the next four years or at least the next two until the midterm elections. As Roseanne Roseannadanna famously said, it's always something. The stock market rallied roughly 5% last week because the odds of a 50 basis point cut at this Fed meeting rose from 30% to 50%. Why did the odds change? It wasn't, as far as I could tell, from any economic news, but there were some monetary influencers (or as they're also known, former Fed employees) who said they thought a larger cut was justified. That most of those former Fed employees have been dead wrong about the economy for the last few years didn't seem to matter because, you know, this time they might have some inside dope. There was also some Twitter post from a WSJ reporter, who is supposedly the Fed's preferred outlet when they want to tell the market something, but they're in a blackout period and can't say anything themselves. He's known as the Fed whisperer, but my guess is that he gets better access because he wrote a book about how the heroic Fed saved us from economic doom during COVID. Flattery will get you everywhere in DC. All of this speculation about the Fed's next move is ridiculous, a waste of time for long-term investors. There are a million things that influence the future course of the economy, the change in short-term interest rates being only one. The rate of change of economic growth and/or inflation can and is influenced by monetary, fiscal and regulatory policy, but the economy also changes independent of those things. You cannot disaggregate all the discreet influences over nominal and real economic growth. You can't quantify the impact on the economy of a quarter or half percent change in short-term interest rates or changes in demographics or new technology developments or the make up of Congress. Economists can't even agree on what caused past changes in the economy, much less ones that haven't happened yet. The economic recovery from the COVID recession - I am hesitant to even call it a recession lest anyone confuse it with any of the other 7 we've had over the last 60 years - has been odd to say the least. A huge fiscal response, zero interest rates, QE, tangled supply chains, an inflation spike like nothing seen since the 1970s, the lowest mortgage rates ever recorded, huge cash infusions to households and corporations and more have combined to make this economy completely unmoored from the past. The Conference Board's leading economic indicators, which worked to predict recession for decades, have stopped working. The LEI signaled recession starting in 2022 and continued to do so until about 4 months ago, just about the time everyone started fretting in earnest, again, about the onset of recession. The 10/2 yield curve has recently turned positive after spending a record amount of time in negative territory, and there is still no recession in sight. And even though it is a unique period, so are all the other expansions and contractions I've experienced in over 30 years of investing. Some of these "surefire" economic indicators were probably nothing of the sort; we don't have nearly enough data on, say, yield curve inversions to say for sure. The LEI is made up, mostly, of indicators about the manufacturing part of the economy, which isn't nearly as important to overall economic growth today as it was 20, 30 or 50 years ago. Or maybe the LEI isn't working because of the uneven recovery during COVID, where goods consumption soared in the early part when everyone was stuck at home and the services part has been booming the last two years due to pent up demand that was unleashed after the introduction of vaccines. And I wouldn't be surprised if we get another shift back toward goods and away from services as interest rates come back down. The aftershocks from COVID may not be over yet. Simple rules of thumb - like the Sahm Rule or the LEI or the yield curve - are not going to cut it in this economy. Investors need to think more critically about the old ways of doing things. Be skeptical, cynical even, of pronouncements from the Fed or anyone else about the future course of the economy. Pay less attention to the Fed and the other economic soothsayers and more attention to markets. Trust the wisdom of crowds over the wisdom of the 12 people on the FOMC. And just spend more time thinking, about how things have changed and how they haven't. The economy may have changed since COVID, but markets have not. Markets are driven by emotions, and those who act unemotionally can take advantage of that fact. But if you spend your time thinking about things like whether the Fed will cut 25 or 50 basis points this week, you are going to get caught in the same emotional trap as everyone else. I don't know when the next recession will arrive and neither does anyone else but we will have one. All I can tell you is that, based on the available data, we are not in recession right now and that won't be changed by whatever the Fed does this week. Joe Calhoun Environment The dollar index has been in a short-term downtrend since the spring but it is still in the same trading range it has inhabited since the end of 2022. This trading range will eventually give way, but the timing of that move is not something we can predict in advance. In fact, we can't even really say whether it will break the range by rising or falling, although I do think a fall is more likely. We won't act on my expectation though because the future direction of the dollar will depend on a wide variety of factors I can't predict. I would have to predict not only future US economic policy but also the policies of other countries and the market reaction to those policies. Instead, we invest based on the current short, intermediate, and long-term trends. The practical implication of the current trend is that we incorporate some weak dollar investments in our portfolio, but less than we would if the short-term downtrend were to extend below the current trading range. The Fed meeting next week seems likely to determine whether the dollar breaks lower or rebounds into the existing trading range. With expectations building last week for a 50 basis point cut, a 25 basis point would likely move the dollar higher short-term. If it does break lower into that lower channel, I would expect it to fall pretty rapidly toward the bottom of the range. Interest rates were down slightly last week, but the 10-year rate continues, like the dollar, trade in a tight range. Yes, it is in a short-term downtrend, but it has been a slow grind lower and the rate is essentially unchanged from 2-years ago. The 2-year Treasury note yield also fell last week but only about 5 basis points. It is also at the bottom of its range, and the Fed meeting will likely determine the next move. Assets that respond favorably to falling rates (REITs, bonds, dividends) have had a big surge over the last 3 months. Growth stocks, which usually perform well when rates fall, have not. Looking at the past to see what assets perform well in any given environment gives you tendencies, not certainties. Markets Stocks had a very good week based on rising expectations for a 50 basis point cut at this week's FOMC meeting. Those rising expectations though were based on...not much. The market has done this repeatedly this year, pricing in multiple cuts that have to be scaled back because the economy doesn't cooperate. At the beginning of the year, expectations had to be dialed back because of some hotter-than-expected inflation reports. Now investors are more focused on economic growth, and I suspect the easy money crowd will be disappointed again. There have been some indications of nascent economic weakness, but the economy appears to be growing at a trend of 2-2.5% in the current quarter. Growth stocks outperformed last week, but the last three years still favor value by a nearly 2%/year margin. REITs had another good week, but I'd be wary of putting on new positions after a big run. If the Fed disappoints this week and rates move up, REITs will likely get a well-deserved correction. Commodities continue to struggle despite a weaker dollar. That is being driven by crude oil, which is down 12.2% over the last three months. That does not appear to be due to a lack of demand, by the way. The futures market remains in backwardation with spot prices higher than futures. That isn't, as I've seen some say recently, an indication the market thinks prices will fall in the future. It is merely a reflection of strong current demand. Non-US stocks have improved over the last three months as the dollar has fallen, with Latin American stocks up nearly 5%. Global stocks ex-US are up 17.6% while the EAFE index (not shown below) is up 19.6%. That lags the US, but not as much I suspect as most people think. International stocks are also a lot cheaper than their US counterparts, but a large allocation to international probably isn't warranted until the dollar gets in a more consistent downtrend. Sectors Technology surged last week but is still down over the last three months and over 7% from the peak in early July. Energy stocks continue to struggle and are now down 4.2% over the last year. Year to date, despite a lot of hoopla, technology ranks in the middle of the pack (6th). Communications services, which includes some tech-adjacent names, is the second-best performer, but defensive sectors like utilities, consumer defensive, and healthcare are also near the top. Utilities have been touted as an AI play, and they are certainly priced that way at nearly 19 times next year's earnings estimates. They are also sensitive to interest rates though and that has certainly played a role. Market/Economic Indicators Last week's economic reports: Redbook same store retails sales +6.5% year over year. This has been rising since last summer. CPI up 0.2%, core up 0.3% month to month, 2.5% and 3.2% respectively year over year. The core was a little higher than expected but no real surprises here. PPI up 0.2%, core up 0.3% month to month, 1.7% and 2.4% respectively year over year. Both 0.1% higher than expected but pretty tame. Jobless claims 230k. Still no sign of sustained labor market weakness Import prices -0.3%, export prices -0.7%. Year over year +0.8% and -0.7% respectively. Most of the drop in import and export prices was due to crude oil. We still import a lot of crude because our refineries aren't set up for light sweet crude. The overall economic picture, based on the most recent data, is one of steady, trend growth and inflation continuing to fall back to trend. Inflation is still too high, and I wouldn't bet on it getting back to the pre-COVID trend of less than 2%, but for now, it is on a trend that should allow the Fed to cut rates. The question is how much. Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Joe has worked in the financial services industry since 1992 in various capacities, including Operations Manager, Compliance Manager, Registered Representative and Portfolio Manager. From 1997 to 2006, when he founded Alhambra Investment Management, Mr. Calhoun was a Director of Investments at Oppenheimer & Co. Mr. Calhoun holds the Series 63 (Uniform Securities Agent State Law) and 65 (Uniform Investment Advisor Law) securities licenses. He has previously taken and passed the Series 7 (General Securities Representative) and Series 9/10 (General Securities Sales Supervisor) securities exams. Joe proudly served in the U.S. Navy's nuclear submarine service for 8 years (1983-1990) and was awarded several commendations including the Navy Achievement Medal in 1987. He studied engineering at the University of South Carolina and is a graduate of the U.S. Navy's Nuclear Propulsion School. He founded Alhambra Investment Management as a registered investment advisory to address the needs of the individual investor. His market commentaries are widely read and published at various online outlets. He has appeared on Larry Kudlow's program on CNBC and various radio programs. He is also an editor of the website RealClearMarkets.com.
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The Federal Reserve faces a critical decision on interest rates, with markets and analysts anticipating a potential cut. This move could mark a significant shift in monetary policy, impacting various sectors of the economy.
As the Federal Reserve approaches its next policy meeting, anticipation is building around a potential interest rate cut. This decision comes after a prolonged period of monetary tightening, with the current federal funds rate target range at 5.25% to 5.50% 1. The central bank faces a delicate balance between addressing inflation concerns and supporting economic growth.
Financial markets have been pricing in the likelihood of rate cuts, with expectations of multiple reductions throughout the year. The CME FedWatch Tool indicates a high probability of a 25 basis point cut at the upcoming meeting 2. This anticipation has already influenced various asset classes, including stocks, bonds, and currencies.
Recent economic data presents a mixed picture, complicating the Fed's decision-making process. While inflation has shown signs of moderating, it remains above the Fed's 2% target. Additionally, the labor market has displayed resilience, with unemployment rates near historic lows 3. These factors contribute to the "close call" nature of the upcoming decision.
A rate cut could have far-reaching implications across various sectors of the economy:
The Fed's decision will have global repercussions, influencing currency exchange rates and international trade dynamics. Central banks worldwide are closely monitoring the Fed's actions, as they may need to adjust their own monetary policies in response 5.
As markets brace for the Fed's announcement, volatility is expected to increase. Investors and analysts are not only focused on the immediate decision but also on the Fed's forward guidance and economic projections. The central bank's communication will be crucial in shaping market expectations and economic sentiment in the coming months.
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Central banks worldwide are considering rate cuts to stimulate economic growth, but concerns about inflation and geopolitical tensions continue to impact market sentiment.
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As inflation stabilizes, economists debate the Federal Reserve's next move. Some argue for rate cuts to boost growth, while others caution against premature action.
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As the Federal Reserve signals potential rate cuts, investors are preparing for a significant market rotation. The focus is shifting from high-performing tech stocks to undervalued sectors, potentially reshaping the investment landscape in the ongoing bull market.
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As the Federal Reserve prepares for a pivotal interest rate decision, investors are strategically positioning themselves through various ETFs. This article explores the top ETF choices and their potential implications in the current economic climate.
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As the Federal Reserve signals potential interest rate cuts, investors are expanding their focus beyond Big Tech stocks. This shift is driving interest in small-cap stocks and previously underperforming sectors, reshaping market dynamics.
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