Investors Must Watch These Economic Risks as Fed Prepares Rate Cuts
Inflation might finally be contained but investors cannot get complacent as economic metrics deteriorate.
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Investors got what they belief is the "all clear" sign on inflation being finally contained Thursday before the opening bell. The June CPI fell by .1%, while the core rate only gained .1%, the lowest move up in the core rate since April 2021.
I will go on record as saying that I take government statistics around the jobs market, inflation and most other economic reports with a large grain of salt. However, what this reading did do is lock in the narrative that the Federal Reserve will cut the Fed funds rate at the September FOMC meeting. Or, at least, futures are now pricing in a 90% chance of a cut in two months.
Investors should be careful about what they wish for, however. The central bank is almost behind the curve, going in both economic directions. Need I remind everyone on how inflation was supposed to be "temporary" and"transitionary" throughout most of 2021?
In addition, in most cycles, the Federal Reserve only starts to cut rates when the economy is already in recession or destined to soon enter one. Let’s not forget that the central bank started to cut the Fed funds rate from 5.25% in September 2007, several months after Chairman Bernanke ensured all that the subprime crisis was "contained." Seven months later, they had slashed interest rates all the way down to 2%, which still didn't prevent the debacle ahead.
Most of the economy does seem to be deteriorating in recent months. The unemployment rate has moved up from 3.5% to 4.1% over the past year while GDP growth has slowed dramatically in the first half of this year. The market provides almost daily warnings that there is more weakness around the consumer, which drives nearly 70% of economic activity. On Thursday, it was Delta Air Lines (DAL) and PepsiCo, Inc. PEP that confirmed the North American consumer is not in good shape.
Office vacancy rates (20.1%) in the second quarter also just hit an all-time high as well. This does portend good things for the already-challenged commercial real estate sector. Earlier this week, S&P Global Intelligence showed that 75 companies filed for bankruptcy in June. This was the highest monthly total since the COVID lockdowns. Bankruptcies in the first six months of this year are at their highest level in 13 years as well.
Given how I always like to end the week on a high note, it was nice to finally see some sector rotation into the laggards of the market on Thursday. In fact, it was one of the steepest one-day reversals in recent memory. Some profit taking finally hit the Magnificent Seven and the Nasdaq nearly 2% on the day. Meanwhile, the Russell 2000 was up over 3.5%. To put this in perspective, this small-cap index was up just a bit over 1% in the first six months of 2024.
I will be watching to see in the coming weeks if this is the beginning of a long-overdue sector rotation. First, because most of my covered call holdings are around small- and mid-cap names. More importantly, the lousy market breadth throughout 2024 was one of my biggest concerns around equities. I will also be monitoring to see, now that we have a firm date for when cuts to Fed funds rate will begin, if that makes any difference to the overall economy or whether economic metrics will continue to deteriorate.
One thing I will not be doing is getting complacent even now that the "cavalry" finally appears to be on its way.
At the time of publication, Jensen had no positions in any securities mentioned.
