Stocks rallied on Friday, with a sigh of relief, as Fed Chief Powell finally caved. New Home Sales surged unexpectedly in July – possible proof that lower interest rates can indeed increase demand… and possible inflation.
And in this corner. I know that it’s early days, but I feel like I have to get it out on the table as soon as possible. I am away at my secret spot in Cape Cod, but packed in my bags, with lots of pink and blue clothes, is my trusty, but not too rusty, book of Wall Street Sayings. I have it opened to a well-worn page that reads simply, “Don’t fight the Fed!” That’s right, my friends, don’t fight the Fed.
Last time I opened it to that page was sometime in 2021 as inflation started to pick up and the late-to-the-picnic Fed started to notice that inflation may not just be “transitory.” Some of the hawkier hawks started messaging their concerns, usually on Fridays. They did this in an attempt to stay out of the main news cycle, but this had the opposite effect as markets tend to have lower volume on Fridays and are thus subject to bigger moves in some cases. ANYWAY, investors at the time found themselves having to wrestle with the idea that the Fed would, at some point, raise interest rates and possibly put an end to the party.
Prior to 2021, the last time the Fed raised rates was in December of 2018 and the stock market didn’t exactly take kindly to the move. You may recall the worst December for stocks since The Great Depression. Yes, the one with the capital “T” and the capital “D.” Thankfully, the slide in equities was met with Powell’s famous capitulation in the final days of the year. That shift in sentiment from hawk to dove set the stage for interest rate cuts that would come in the summer of the following year; however, the admission allowed the stock market to rally for the first half of the year, only to languish through early summer. But that sideways trade was met by the powerful hammer of the Fed in July. In that case the hammer was applied to interest rates, as they were cut. That cut and the two that followed was a principal driver for the S&P500’s almost +29% return for the year.
It was a tough year for short-sellers… who may have missed the memo about fighting the Fed. Interestingly the old adage is more typically applied to the Fed’s hawkish activities, warning the bulls to heed to the Central Bank. The ones that didn’t, had a rough go in 2022. But here we are in late summer of 2024. Inflation is retreating, the economy is holding on, and employment is showing signs of weakness. This seems to be a perfect setup for the Fed to do its business, the way it is intended to do so: keep inflation under control while maintaining a healthy labor market. At this stage the only way to do that is to lower interest rates. And to avoid missing its mark as it famously did at the beginning of the inflation cycle, the Central Bank must act… now… er, in September. That’s only a few weeks away, so the Powell used the pulpit at Jackson Hole to signal a move. “The time has come for policy to adjust,” said the Fed Head to a collection of snoozing economists and eager journalists. That was it, and everything else he or anyone else said at the Comic-Con of central bankers was… not noteworthy.
So, interest rates are coming down. How much and exactly when and precisely how quickly is still unknown. Futures traders are counting on, at least, a -25 basis-point decrease in September with a 36% chance of another -25 basis-point decrease. That’s not great odds for Wall Street. After September, the Fed has two more meetings before we bid good riddance to 2024, and futures are factoring in a 100% chance that rates will be 1 full percentage point lower by the end of the year. If you have been following my math, that would mean that we would get a -25 basis-point cut in a few weeks, and the Fed would have only 2 meetings to lower them another -75 basis points, so one of the FOMC meetings would have to include a -50 basis-point cut… if futures traders are right.
In reality, the exact path of interest rates for the remainder of the year and beyond will very much be dictated by the economic numbers. If inflation ticks up, then the path would surely be shallower, or slower. If the economy shows increased signs of weakening, the path can be steeper or faster. We can expect much speculation around that path with the release of each number going forward. That will mean lots of potential volatility if the numbers miss forecasts on either side. But the message I want to leave you with is that the Fed has pivoted, and regardless of the path, interest rates are coming down. If you don’t want to heed my message, fine, it’s your choice, but if you do, you need to recognize the implications lower interest rates will have on your portfolio, both positive and negative. Don’t fight the Fed.
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