Cutting Rates Now or Later, the Fed Is Too Late to Salvage Alarming Trajectory
All eyes are on the Federal Reserve as it prepares for the first post-pandemic interest rate cuts, but there are bigger issues at hand.
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Over the last few weeks, we have seen the large-cap tech stocks, the Magnificent 7, lose about $2.6 trillion in value.
Nvidia NVDA has erased about $1 trillion in value alone. Since the stocks hit a low back in October 2022 when ChatGPT announced the release of AI, these stocks have been on a one-way tear that lasted all the way until the beginning of July. But something snapped a few weeks ago and the large stocks are down between 15% and 20%.
In the grand scheme of things, these stocks are still up between 50% and 200%, so it is hardly a dip lower. But, as the numbers are reported, the bar is high as these stocks are priced for perfection with little margin of error. To justify their multiples today, they not only need to beat, but beat by a high margin. Microsoft MSFT reported a small beat, but with disappointing cloud revenue and disappointing guidance. Google fell 7% after reporting good numbers which were all in line. This says it all: As these stocks have now pulled back to their 100-day moving averages, the market is used to the old playbook to "buy the dip."
The momentum fueling this belief is that the Fed is set to cut rates, and thereby curtail any softness in the U.S. economic growth landscape, achieving a full recovery by the end of the year. After the Fed's fastest rate rise campaign in its history, rates are starting to feel too restrictive as seen in the various PMI, ISM and home sales data.
The consumer is showing signs of feeling constrained and this is evident in all of the metrics that track consumer confidence to their appetite. The Fed needs to cut as mortgage rates are too restrictive for businesses and consumers but, at the same time, the Fed is adamant about its dual mandate of employment and inflation. The latest jobs data has shown job openings slowing down, normalizing, but not yet falling off a cliff. The unemployment rate is ticking higher but not at a level that should concern the Fed, for now. The inflation rate has been falling, thanks to China's deflationary slowdown.
But it is not all immaculate, as the U.S. has been slowing down a lot faster than the top-level numbers show, thanks to Biden's massive fiscal spend. Truth be told, the Fed does not have enough ammunition to cut today or even in September, even though the system is flashing red. They cannot let inflation get out of control. Even though the rate of change is ticking lower, that does not mean it cannot go back higher.
Investors are programmed to buy the market after the first cut. In fact, most are staying long looking past the slowdown as they are convinced the Fed will cut and save them. But the timing of the cycle is more important than the cut itself. Looking back historically, when the Fed has eased during a recession or a slowdown, it has taken several cuts to get the market to bounce. If the Fed cuts during a growth phase, then markets do rally. The jury is out about where we are in the cycle and that is a big difference. Whether we get a Goldilocks-style recovery or a stagflationary bounce remains to be seen. In 2008, the markets fell much more and for a lot longer after the first cut. So be careful what you wish for.
All eyes will be on Chairman Powell: Will he succumb to the pressure to cut rates sooner or wait till after the U.S. elections? Then again, regardless of whichever candidate comes to power, the U.S. fiscal deficit is set to widen even further as neither candidate is interested in austerity or cutting back. There is no end to the U.S. debt trajectory and this is something the Fed knows all too well. But it's lost as to how to salvage it.
