Markets are cycling through denial, anger, and depression over Fed rate cuts—Powell at Jackson Hole won’t make it easier.
KEY TAKEAWAYS
MY HOT TAKES
Stages of mourning. Mourning? That’s a sullen way to start your day, isn’t it? There are said to be five stages of mourning: denial, anger, bargaining, depression, and acceptance . These describe the emotional process people often experience after a loss. While not everyone goes through them in order, these generally accepted stages capture the common arc of moving from shock and resistance toward eventual adaptation and peace.
If you have been only half-paying attention to markets over the last four months or so, you probably found yourself going from nervous and scared, which led to hope, surprise, confusion, and then elation as you watched the S&P 500 tally some 30% from April lows through last week. And it wasn’t an easy journey. Stocks had overcome quite a bit of adversity during that period of explosive growth.
First, and most obvious are tariffs. Guys, COMPANIES ARE BEING CHARGED TARIFFS AS WE SPEAK. They are real and they are here. Put more bluntly, US companies are being taxed some 16% more on their imports than a year ago. That’s gotta mean something. Let’s not get into the discussion of whether they are good or bad. What is important–for markets at least–is that they are a new unknown to contend with. On Wall Street, we love to look back at history as a reference point.
I remember when COVID first hit the US, I wrote a series of market notes–PERHAPS YOU WERE A FOLLOWER BACK THEN–which played on the 28 Days Later theme (a cult classic zombie franchise). In retrospect, it was kind-of macabre and dark, but those were early days, and we had no idea what was in store for us. I remember looking back at all the virus outbreaks that preceded it and was able to get an idea of how the market would react and for how long. The bottom line is that nothing came close to the magnitude of what COVID would bring to society, the economy, and the markets.
Though it seems odd, the current state of tariffs, similarly, has no historical analog from which we can learn from. None. So, in essence, we are in uncharted waters, relying on abstracted economic models stitched together with best-guesses. The fact of the matter is: we just don’t really know. In microeconomics, we do have a solid understanding of pricing power and elasticity, as well as the Tax Incidence Theory, so we are able to fathom a world where consumers may end up paying most of the bill. “Higher prices” is another way of saying: inflation.
Inflation, a problem which has gained recent infamy in the wake of the pandemic–oddly, some 28 months after it hit. 😦 Snarled supply chains sparked the flames and heavy-handed stimulus fueled what became a raging dumpster fire. First an unprecedented economic lockdown, then an unprecedented stimulus which led to unprecedented inflation, which was followed by unprecedented monetary tightening by the Fed. Wow… unprecedented.
That was all behind when inflation ebbed and headed back toward the Fed’s 2% target in earnest. The Fed fed (🤣) us a few rate cuts, and we were off to the races. President Trump's election brought with it hopes of further growth from his pro-growth policies. Then came those tariffs that we talked about before.
That leaves us with confusion over what tariffs means, confusion over what the tariffs actually are (they are confusing and constantly changing), and confusion over inflation. Are you confused about inflation? You are not alone. The smartest and most powerful economist-bankers in the world are confused as well.
Fed policymakers have literally locked themselves in a closet on policy. They are worried that inflation will come back and that lowering rates will fuel it. Well, it has come back, a little bit. We can see a slightly elevated trend in goods wholesale and retail prices. However, it is not in any way like the inflation we saw in 2022 and 2023, and it is likely to be transitory. Still painful for consumers but not sustained pain. This should make it less of a concern for the Fed, but having totally failed the last time inflation popped up, we can all understand that policymakers are a bit gun-shy.
Now, I am not going to get into the AI and tech trade. It’s here, we know it, it’s big, and it is just the beginning. It has helped markets stage their most recent comeback. Interestingly, in the rebound, tech and AI lagged at the early stages but carried most of the latter portion. We are in the final days of Q2 earnings season, and it has been a jolly good one–unexpected even by the most bullish of us. To date, S&P 500 companies beat by almost 8% with a year-over-year EPS growth of almost 11%. That’s really solid!
All of these things together have yielded 13 record closes year-to-date–the good and the bad. Three of those record closes came as recently as last week. But what is driving the markets these days. More important yet, what will it take to move markets even higher? Really there is only one thing, and that is Fed rate cuts.
The President has his own reason to want lower interest rates–a topic for another discussion. The equity market wants rate cuts to fuel the next leg of its rally. After the weaker-than-expected employment numbers at the beginning of the month along with a benign CPI / PPI print, markets have come to expect a rate cut–sitting at the table, napkin tucked into shirt, fork and knife in hand.
There is only one problem. The dinner bell has not been rung yet. The next Fed rate decision is almost 4 weeks from now, which means that the market today can only dream of it. But something changed earlier this week. Consecutive highs have given way to consecutive losses.
Fed speakers have not exactly been telegraphing rate cuts. On the contrary, even the dovish-leaning FOMC members have been striking a more cautious tone. Treasury Secretary Scott Bessent told us that “certain models” show that interest rates should be 150 basis points lower. Those “certain models” have not been produced and I am sure he wishes that he just said, “we would like to see rates lower.” But his statement sparked a lively debate about why rates should not come down. That brings us to Monday morning, on which a good portion of the Wall Street community didn’t know about Jackson Hole. You see, traders were in denial that rates may not be cut in September. This led to anger and bargaining as markets attempted to sidestep the challenge. By yesterday’s close, it was clear that depression set in. Fed Funds futures give a 70% chance of a September rate cut, which is not small, but far lower than it was last week. Polymarket betting markets give a rate cut a 56% chance. Still technically positive, but certainly not a lock-in by Wall Street standards.
Folks, what we are witnessing is a market in mourning, trying to wrap its emotions around the reality that it may not get a rate cut next month. This morning Fed Chair Powell will speak at Jackson Hole. Markets are hopeful that he will admit his support for rate cuts. Spoiler-it is not likely. With the next policy meeting so far off and a still clear majority of FOMC members seeming to favor a wait-and-see approach, the Chair is likely to receive any positive guidance for the meeting itself.
I have been saddened to see how quick the media has rushed to call this the beginning of an AI Winter or an AI Bubble Pop. This is neither. It is a market in mourning, trying to come to grips that it may not get the September rate cut it so desperately desires. Tech is being hit hard because it is dominated by high-beta stocks.
We still have several weeks and some really important economic data points to contend with. Next week, we will get PCE Inflation and consumer spending. The week after we will get another monthly jobs report–the last three prints were abysmal and another would be alarming, even to the paralyzed Fed. Then we will get another run of inflation numbers from BEA before the next meeting. Those numbers will be the factors that will have an impact on that rate decision.
Powell is not likely to risk jumping the gun with any consolations today. It is therefore likely that the markets will be left to pull through its depression. The sooner it is able to accept the reality; however, things could be dicey. Stepping back, this pattern will likely dominate most of the remainder of the year–at least around the two FOMC meetings that follow September’s. Don’t get caught up in all the emotions and headlines in search of news! Stay focused on the long-term–you will win. Your acceptance that volatility is the price for great returns will help you sleep better at night.
YESTERDAY’S MARKETS
Stocks fell yesterday as traders were on edge ahead of this morning’s Jackson Hole speech from Powell. Hawkish statements from FOMC member Beth Hammack added to the selling pressure–she is one of the most hawkish and she is not a voting member, which shows just how sensitive the markets are to interest rate policy at the moment.
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