It's Clear Now That the Fed Jumped the Gun With Rate Cuts
After seeming to give into political pressure by cutting interest rates, the Federal Reserve has set equities up for a rude awakening.
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2024 has been a year of constant Federal Reserve flip-flopping, to cut or not to cut. Perhaps Shakespeare needs a rewrite.
As the data and seasonality ensued, the bond markets moved accordingly, and the Fed — being data dependent — seems to be on the back foot each time, chasing the narrative in the bond market. We came into this year expecting 150 BPS of cuts to then move to none as the economy performed very well in the first half. Then, as the summer progressed, the bond market picked up on the massive slowdown in manufacturing once again and all the recessionary indicators, pricing in about 200 BPS of cuts in one year. This caused the Fed to panic in October, a month before the U.S. presidential election, whereby they would be damned if they cut and damned if they did not.
At the October FOMC meeting, the Fed cut rates by 50 BPS, and suggested they would most likely cut by another 50 BPS later this year. Surprisingly after this meeting, the bond market actually fell, dragging the yields from lows of 3.5% on the 10-year all the way to 4.09% as the U.S. economic data, in fact, showed some "seasonal" adjustments post Hurricane Helene and temporary softness over the summer.
Imagine a dovish Fed, and the bond market just ignoring it entirely. So much for their credibility.
It seemed quite odd for the Fed to blink when CPI, even though moving in the right direction, was still averaging closer to 2.9% to 3.2%. But if one looked at the super core services CPI ex. housing index, which is what the Fed alludes to, it showed inflation being quite sticky, around 4%-plus. It seems a terrible time to even consider cutting rates as once inflation comes out of the bottle, they may need to do another 2022 again!
If the Fed keeps cutting, it will be feeding a Goldilocks economy. But the market cannot have both a soft-landing narrative and a bond market pricing in 200 BPS of cuts. Since the meeting, the bond market has reversed its dovishness, but the equity market is still hanging its hat on the fact that the Fed will keep cutting by another 150 BPS.
On Thursday, we saw the U.S. retail sales number come in at +0.4% versus expectations of +0.3%, retail sales ex auto +0.5% versus expectations of +0.1% and retail sales control group +0.7% versus expectations of +0.3%. This was the biggest positive September seasonal adjustment in history. Whether it has something to do with the elections is contentious, but taking the data at face value, it shows that the U.S. consumer is still holding on, even though inflation-adjusted numbers are lower year over year.
We got the initial jobless claims and, after last week's storm- and strike-driven surge, the headline data slipped back from 260,000 (revised higher) to 241,000. So, it seems the labor market is not rolling over as the Fed was worried about it.
The Fed continues to insist that they are apolitical. But, given the pressure from Nancy Pelosi and others insinuating aggressive cuts were needed, it seems the Fed bent to their will, or just really did not want to have the market collapse on their watch before the election. They keep saying "more work needs to be done" and so they need to be vigilant and stay the course, so why cut more?
As the dollar rallies and the bond market prices out these cuts, it will only be a matter of time until the equity market wakes up and realizes that perhaps they need to use a much higher permanent cost of capital and the days of negative interest rates are perhaps gone forever, one for the history books or a bedtime story to read to our grandkids of the good ol' days of free money.
At the time of publication, Bengali had no positions in any securities mentioned.
