Your rate cut rundown – what happened and what to expect going forward

The small cap index closed slightly in the green with bigger siblings closing down as the fed cut its key lending rate by ½ a percentage point. Housing Starts and new Building Permits came in above expectations in possible anticipation of a lower interest rate regime.

And… cut… that’s a wrap. So, the Fed gave us 2 Oreo Cookies when we would have been happy with just 1, but we would have been ecstatic to get 3, though we didn’t expect it, also knowing that 3 Oreos would mean trouble. For those of my readers who don’t know what an Oreo is, it is a mass-produced cookie that consists of two crunchy chocolate layers sandwiched around a sweet creamy layer (not quite sure how to describe what the cream is actually made of). Anyway, it is an American classic that dates to the early 1900s. The thing is with Oreos is that one can never seem to get enough of them. I am not a huge fan, but I have to admit that yours truly has finished an entire sleave of them in one sitting after only fishing for just 1 or 2.

If you asked me a week or 2 ago, I would have expected a -25 basis-point cut expecting this mostly conservative Fed to err on the side of… conservatism. A gesture that they are on it and that things are getting back to normal, while simultaneously signaling that they are not worried about the economy. But alas, the bankers delivered what is considered an oversized move, by historical standards. The Fed most often moves in -25 basis-point steps… unless it is putting out a fire. Remember that big cut at the beginning of the pandemic? That was a fire to be put out. How about runaway inflation a few years back during which the Fed used oversized rate hikes? That too was a fire.

So, is there a fire now that warrants a big move? Well, based on the Fed’s official release, we can see that the FOMC edited the sentence “Job gains have moderated, and the unemployment rate has moved up but remains low” (from the last release) by simply replacing the word “moderated” with “slowed” in yesterday’s release. In Fed talk “slowed” is worse than “moderated.” The Fed did choose to let us know that it still thinks that unemployment is low, so the message is “no cause for panic.” Looking at the Fed’s economic projections (also released yesterday), it thinks that the unemployment rate will end up at 4.4% by the end of this year and next. In their last projection, released in June, the Fed was predicting 4.0% and 4.2% respectively. The Fed, in their projections, worsened their expectations from June to current. Oh, and the last read of the Unemployment Rate was 4.2%. That means the Fed is expecting it to worsen over the next few months. Aha, that is certainly a reason for why the Fed chose a larger rate cut.

If we go to the Chairman’s statements, the key takeaways were that inflation is easing and GDP is growing, but the labor market is cooling. This is guardedly positive. In his Q&A, the Chairman went out of his way to convey no signs of panic. He insisted that the Fed did not believe that it missed its mark. He further relayed that he did not expect a recession. He also made a point to let us know that -50 basis-point moves were not the new norm, and that the magnitude of any future cuts would be determined by economic health.

Going back to the Fed’s projections, the median FOMC members’ expectation for Fed Funds by yearend is 4.4%, lower than its June projection of 5.1%. After yesterday’s cut that would mean the Fed currently expects 2 more -25 basis point cuts by the end of the year. This morning’s Fed Funds futures predict at least 2 and an 86% chance of a third. That’s a good chance by Wall Street standards.

Looking at the markets’ reaction to the news, volatility ensued after the announcement. That is normal and not surprising. 2-year Treasury Note yields fell immediately after but ultimately climbed into the close. 10-year Treasury Note yields initially fell but ultimately climbed closing higher for the day. This can be interpreted as the bond market adjusting after possibly being too optimistic about rate cuts prior to the news. The 10-year yield gains can also be a reflection that bond traders may be expecting more inflation in the future based on the possibly aggressive rate cutting cycle. Stocks reacted with a ramp-up in volatility in which the major indexes closed down but mostly unchanged from where they were prior to the announcement. The possible explanation for this can be found in my dusty old Wall Street sayings book, on a well-worn page that reads “buy the rumor, sell the news.” We see this play out often when companies beat analyst estimates, but the stock goes down because the market was secretly hoping for even more.

SO then, the market got what it wanted, the Fed is not worried, and rates have now all adjusted to this new era of Fed dovishness. What does this mean for your portfolios going forward? Well, if we can avoid a recession, history shows that stocks tend to rally in the12 months after a first cut. But history is no guarantee on Wall Street, it is just an observation. Indeed, but traders will certainly pull the tarps off their old favorite “Fed Put,” which implies that the Fed will continue to cut rates to keep the markets… er, the economy buoyant. The Fed is now in a rate-cutting cycle. That means borrowing costs will go down for consumers and companies at some point in the future (not quite yet though). That should improve not only consumer confidence but investor confidence as well. Overall, that is positive for stocks in the near to mid-terms, but there is a caveat, however. The economy has to continue to stay somewhat healthy. That throws into sharp focus all economic releases going forward in which good will be good and bad will be bad once again. For bond investors, there is good and bad news. Investors who took advantage of short-maturity treasuries’ higher yields (T-bills), those have already adjusted lower, and they will get lower yet as the Fed continues to cut. Longer-maturity bonds can do better, especially if things start to get rough for the economy, but that would be bad news for your stock portfolio.

Finally, the market needs to enjoy the 2 Oreos and remain satisfied with them until at least November 7^th when the Fed meets again to decide on rate policy. For those of you who haven’t heard of Oreos until today, here is a little insider secret. You can pull them apart and turn them into 2 cookies! You might even choose to eat the cream before eating the cookies which will further extend the period of satisfaction. Still, eating just 2 is really difficult, and we are always left wanting for more, even though we know it is not good for us. For now, be satisfied with this rate cut and focus on economic health, and more importantly, corporate health; earnings season starts in 3 weeks 😉.

YESTERDAY’S MARKETS

NEXT UP

• Leading Economic Index (August) is expected to have slipped by -0.3% after giving up -0.6% in the prior release.
• Existing Home Sales (August) may have pulled back by -1.3% after gaining as much in July.
• After the closing bell earnings announcements: FedEx and Lennar.

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