Big cut, small cut, any cut at all

Stocks rallied on Friday as traders upped bets on a bigger up front rate cut at this week’s long-awaited FOMC meeting. University of Michigan Sentiment showed consumer confidence and lower inflation expectations for the upcoming year – both positive signs.

Move on. Just when you think the discussion is over, you realize that it isn’t. It seems like a lifetime ago that I told Yahoo Finance anchors Seana Smith and Brad Smith that a base case for rate cuts through December was 3 times -25 basis-point cuts. I shared that in the wake of a mostly in-line CPI figure which included a still-sticky housing inflation category. Of course, I added something like “given what we know today,” fully knowing that things would change in the coming months, if not days. Interestingly, nothing really has changed since I gave that live TV interview. Well, there was an admission from a former NY Fed boss that a -50 basis-point cut would be on the table AND a Wall Street Journal article stating that Fed officials were considering a -50 basis-point cut this Wednesday.

Those are indeed noteworthy, and they were certainly… um, noted by the market as futures upped the probability of a larger cut to around 60% the last time I checked. It changes often, but a greater than 50% chance is considered respectable odds on Wall Street. So, The Street thinks that it’s possible to get a bigger cut. That has been broadly cited as the reason for Friday’s market rally, topping off a positive week that brought equities almost back to where they were before their July swoon.

Can we talk reality for just a moment? From a broader perspective, do you think that a -50 versus a -25 basis-point cut this week will make a difference in economic growth? Remember, the reason that the Fed is considering a cut is to prevent the economy, specifically the labor market, from crashing. Both have shown signs of weakness recently, WHICH WAS LARGELY THE CAUSE for stocks’ getting walloped in the latter half of the summer. Ok, so now the Fed is on it, right? Fed policymakers have looked back at the history of the venerable organization and noted that it has had a great track record of solving economic problems by pushing the economy into recessions. More recently, the Fed can be credited for being late in entering the fight against inflation back in 2021. Given that, perhaps FOMC members are eager to break the cycle of failures by being proactive. Perhaps.

I go back to my question, though. Will a -25 basis-point difference really affect the outcome? Well, folks, it is possible that it already has, and the nerd-bankers haven’t even descended on Washington DC yet. First of all, let’s get something straight. The Fed Funds rate is the rate at which banks borrow and lend BETWEEN THEMSELVES overnight. They push cash around to ensure that they are meeting reserve requirements. I know that you nor any company that you know has ever borrowed money at the Fed Funds rate. Despite this, it is THE front and center conversation in every market-related chat. And I mean EVERY chat; I had one just this weekend as I enjoyed the last licks of the summer sun at the beach.

So, what does affect the health of the economy and, ultimately, your stock portfolio? Perhaps we should take a look at Treasury Note yields. I often remind you that short maturity yields are highly impacted by Fed policy while longer tenors are affected by traders. It is because of this that market strategists watch 2-year Note yields carefully as another sign of market expectations. Check out the following chart of 2-year Note yields over the past year.

Please DO NOT obsess over the details of this chart but DO please recognize how yields fell rather precipitously recently, that they are clearly in a downward trend. This shows that the market is expecting lower yields over the next 2 years. Guess what, the market, as in Treasury yields, also impacts loan rates. In this case shorter maturity loans would be cheaper, JUST BASED ON THE MARKET – remember the Fed has not cut rates… YET. These Treasury yields would impact things like Auto Loans or Adjustable-Rate Mortgages (ARMs), which reset based on current market conditions.

Is there more? Yes, of course there is. How about 30-year fixed mortgage rates? Well, check out the chart that follows. You will observe that 30-year fixed mortgage rates have come down significantly recently, hitting a low in the wake of their peaking at over 8% in 2023, almost – 1 ½ percentage points lower! Take a look and follow me to the finish.

So, as you can see by these two simple examples the markets have already adjusted to a lower rate environment. This, regardless of the Fed and its rate policy later this week. Now, of course, I don’t want to cut those neatly pressed bankers out of this discussion. OF COURSE, if the Fed does something draconian like an even bigger than -50 basis-point cut, or even worse, no cut at all, we can expect these rates that I presented to you to adjust accordingly. But for now, the market… AKA the real world has already become more accommodative to borrowers like you and me. Of course, we need to watch the Fed’s actions very closely this week because, indeed, the markets will react to what the Fed does and says, but just know that in the real world, the game is already afoot.

FRIDAY’S MARKETS

NEXT UP

• Empire Manufacturing (Sept)  may have improved slightly to -4.0 from -4.7.
• Later this week, we will get Retail Sales, Industrial Production, housing numbers, Leading Economic Index, and the FOMC meeting. Download the attached economic calendar for times and details.

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