Think You NEED Lower Interest Rates? Let’s Rethink That.

Lower interest rates aren’t always the answer. The Fed sees strength in the economy, and it’s waiting for real signs of weakness before cutting. Here’s what that means for you.

On pens and rates. In a classic scene from Wolf of Wall Street, Jordan Belfort (played by Leonardo DiCaprio) commands his friend Brad Bodnick, “sell me this pen!” Now, I am not applauding the subject of the movie, which was a sad chapter in Wall Street history, however in a silver lining, the movie has certainly provided us with some entertaining if not learning moments. This scene that I am describing tests a salesman’s aptitude for making a customer believe that they want… need what is being offered. [CUT TO NEXT SCENE]

It is the real world, the real US Economy, and the year is 2025. Present, are no handsome actors, fast cars, or expensive suits. Nope, just a bunch of haggard economists wearing comfortable, stretchy pants, carrying computer with spreadsheets, stacks of papers, and misplaced reading glasses perched on their foreheads. Also present: millions of investors and traders, who unfortunately rely a bit too much on meme-like information to inform their investment decisions. No disrespect to the memes, they have their place, but those memes should only be a starting point for investors.

What I am zeroing in on is interest rates. Let’s start with a quick focus group question. Would you prefer a) higher interest rates, or b) lower interest rates? I am fairly confident that you chose “b”. Unless you are a loan shark, a bank, a credit card company, or a buy-and-hold bond investor, you, in some way benefit from lower interest rates. That is all sensible.

What about stock investors? Are lower interest rates beneficial for their portfolios? Well, if the companies they invest in rely heavily on debt to conduct their businesses, yes indeed, those companies would benefit from lower interest rates. However, most of our favorite, large cap, companies do not rely on debt, and in fact, most of them borrowed a ton of money just before rates rose, further adding to their cash coffers. In other words, they don’t have to borrow money at these higher interest rates. Of course, I am referring to the growth companies that dominate the S&P500. Their success in continuously delivering earnings growth through innovation, is the reason why we continue to invest in them, and it is precisely why they enjoy higher multiples than their non-growth counterparts. Do you think that interest rates have anything to do with their ability to innovate? Of course not. I will leave it there, for now.

Let’s widen out the shot and look at the economy. Are lower interest rates good for the economy? That is a simple answer: yes. The US does rely on debt to conduct its business. It’s not just the Government that borrows lots of money. Consumers use credit to buy homes, cars, appliances, college degrees, and… sadly just about everything, using credit cards. When rates go higher, these items become more expensive. Basic economics alert 🚨: when prices go up, we consume less. That all said, when interest rates are low, the economy, quite simply does better. This just simply supports your correct choice of lower interest rates.

But here is the twist. What if the economy is already doing well? Are interest rates good for a healthy economy? I suppose, you can say “yes” to that. Also, core to economics is the “more is good” assumption, so if low interest rates are good for the economy, then lower interest rates should be even good-er… um, better. But there is a cost of an economy running to hot. And that cost is… wait for it… inflation. So, yes, lower interest rates are good for an economy… to a point. It is a constrained optimization problem.

Now, you have heard me say that the economy is doing well growing between 2.5% and 3%, the labor market is healthy, consumption is solid, and corporate earnings are growing at a respectable clip (12.6% so far, for the S&P500). It would seem that lower interest rates may not be necessary at this point. Oh boy, did I just say something taboo? Well, if you have been following my commentary on this, you should not be surprised. Aside from what futures markets and overnight swaps markets are predicting, it is clear, based purely on economic performance, that the Fed should be in no hurry to lower interest rates at this point. Now, add to that the reality that inflation, while subdued, is far from beaten, I should think that the Fed would be even more likely to put cuts on hold.

Now, add, and I am sorry to have to reiterate this, tariffs. I will just say that it is clear that we can expect some inflationary policies in the next few years. This further adds to the thesis that the Fed may not want to stimulate the economy while inflation is still sticking around, AND we may get some inflationary policy in the near future. Besides, did I mention that we are likely to get some stimulative tax legislation within the next year. That would be good for the economy but may also catalyze further inflation. [CUT TO THE NEXT SCENE]

It is Washington DC, a Fed press conference, and the date is yesterday. The Head Fed is talking to reporters and millions of watchers. This is what he said. The economy is healthy, the labor market is healthy, and inflation is sticky, better, but still not good enough. He also said that the Fed is in charge of interest rates and not the President. Further, he added that the Fed is data dependent, waiting to see, not only how the economy performs in coming months, but also what policies actually come out of the Trump Administration. So, policy WILL be based on policy expectations—new information. Also new-ish, the Chair mentioned that the FOMC does indeed watch stock market behavior. OK, regular followers, you know I have said this over and over. Stock market success adds money to the pockets of investors who may use their gains to consume. Moreover, even consumers who don’t own stocks are more confident when the stock market is rising.💡Because of all these things, the Fed is not cutting interest rates at this point. It will wait until it sees proof that the economy needs stimulating, or worse yet, if it needs squelching, though he does not expect that to be the case.

Are you surprised? You shouldn’t be. Or has someone sold you on the fact that you want… need lower interest rates? Friends, a healthy economy and solid corporate earnings are the two key ingredients for your success. Turning that around, if you have a contracting economy and a weak earnings environment, stocks cannot thrive, even with lower interest rates. Be happy. Don’t forget to pay close attention to earnings and the economic numbers over the next few days.

YESTERDAY’S MARKETS

Stocks rode an uncomfortable rollercoaster yesterday, ultimately closing in the red after the Fed knocked the wind out of traders and Powell helped them back on their feet. The Fed is in a wait-and-see mode with respect to interest rate cuts. Bond yields also had a volatile day of trade with 2-year Notes spiking, pulling back and ultimately adding about 2 basis points, while the 10-year Note spike and pull back ended up unchanged for the day.

NEXT UP

• Annualized Quarterly GDP (Q4) is expected to come in at 2.6%, a decline from last quarters final 3.1% reading.
• Initial Jobless Claims (January 25) is expected to come in at 225k, slightly above last week’s 223k claims.
• Pending Home Sales (December) may have been flat for the month after growing by 2.2% in November.
• Today’s important earnings announcements: Southwest Airlines, PulteGroup, Valero Energy, Northrop Grumman, Comcast, Cardinal Health, International Paper, L3Harris, Sherwin-Williams, Quest Diagnostics, Thermo Fisher Scientific, Mastercard, Tractor Supply, Parker-Hannifin, UPS, Blackstone, Altria, Dow Inc, Cigna, Caterpillar, Apple, ResMed, Visa, Intel, US Steel, and Baker Hughes.

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