Doug Kass: We Can't Just Rate-Cut Our Way Out of This Mess

We've got a lot of talk about the Fed cutting rates. Open market interest rates have slipped over the last two weeks, coinciding with investors' expectations that the Federal Reserve might lower the Fed Funds rate twice this year. As a direct result, equities have rallied from the July lows as optimism that rate cuts will spur economic growth.

But let me remind you of two periods in particular that were bad times to buy stocks: In October 2007, when the Fed first cut rates. And, in 2000, when the Fed, under Alan Greenspan, cut rates.

... So, for those who believe in Goldilocks, I've got a story for you.

And its first chapter begins: A few interest rate cuts will likely fail to improve the U.S. economy....

Just as the lag of monetary tightening was longer than expected -- it was different that time in 2022-2024 -- so may the easing have a lengthier impact, and be different this time, through 2026.

The Fed may be ultimately forced to more aggressively ease next year, raising fears of a resurgence of inflation further down the road. The herd, acting like Pavlov's dogs, may again be wrong in its bullish thesis.

We think that economic (and stock market) optimism is overdone for some of the following reasons:

The U.S. economy is far less interest-rate sensitive than previously assumed.
It took the Fed undertaking the most rapid increase in interest rates in decades to slowly dull domestic economic growth - it follows that it will likely take a rapid decline in interest rates to stabilize/improve economic growth in the U.S.
It has taken more and more debt and money creation to generate a unit of production over the last decade.
The stacked inflation (since 2020) is unique to the last few decades and remains a headwind to the consumer - and no rate cut changes its cumulative impact.
Also unique is the U.S. deficit and burgeoning debt load which acts, increasingly, as a governor to economic growth.
A large swath of disadvantaged U.S. consumers ("the have nots") may not have access to lower cost credit. Underwriting standards will tighten further as the economy moves lower. Moreover, it is unlikely that credit card rates will be lowered commensurate with reduced open market rates.

One vivid example of a changing rate/economy relationship can be seen in the housing market, which was incorrectly forecast by the Federal Reserve and by economists. After 15 years of zero interest rates, consumers had materially reduced their mortgage rates (through new mortgages and refinancing). They were now reluctant to substitute a 3% mortgage rate with a 7% mortgage rate. As a result the supply of homes for sale contracted and home prices remained firm.

Lower interest rates may have the opposite intended effect (especially when it coincides with higher unemployment) bThe following commentaryy finally increasing the supply of homes for sale, serving to pressure home prices.

Bottom Line

Goldilocks is still a well-embedded narrative -- reinforced by the economic cheer leading by Chairman Jerome Powell and his feckless Federal Reserve yesterday.

But the bullish cabal is likely to be disappointed in the next six to 12 months.

More TheStreet Pro:

This commentary was previously published in Doug's Daily Diary on TheStreet Pro on Aug. 1.