Is the Economy Too Strong for a December Rate Cut?
As a number of recent and upcoming data points possibly provide the Fed a reason to pause at its next policy meeting, we’re contemplating moves with two portfolio holdings.
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Yesterday the Atlanta Fed GDPNow model was updated, showing 3.2% growth for the current quarter compared to 2.8% for Q3 2024 and 3.0% in Q2 2024. That's good news for the economy but not necessarily good news when it comes to a December rate cut by the Fed.
While the drop in the Prices component found in yesterday’s November ISM Manufacturing PMI was a welcomed development, the subsequent upward revision to that GDPNow model raises the following question: Is the economy too strong for a December rate cut by the Fed?
Economic data later this week, including tomorrow’s November ADP Employment Change Report and ISM’s November Service PMI data, will bring more clues that will help us answer that question. What they show will also help frame expectations for Friday’s November Employment Report, which as of now is expected to show 200,000 jobs added during the month. And because the initial findings of the October Employment Report were quite the outlier due to the impact of back-to-back hurricanes, we’ll be interested in what Friday’s revised figures show.
There are reasons to think tomorrow’s November Service PMI data from ISM will fall into the camp of good news for the economy but not good news for a December rate cut. These include the recent strength in ISM Services PMI New Orders and last week’s Flash November PMI data from S&P Global that found “a surge in service sector activity” with output for that part of the economy rising at the fastest rate since March 2022. Flash new order activity for the services sector was also robust, which suggests the services economy will finish 2024 on a solid note.
As we contemplate all that, yesterday Federal Reserve Governor Christopher Waller said he is currently leaning toward another rate cut in the next few weeks. However, Waller admitted that position could change depending "on whether data that we will receive before then surprises to the upside and alters my forecast for the path of inflation."
While the market will look at comments from Fed Governor Adriana Kugler and Chicago Fed President Austan Goolsbee today, it will be comments from Fed Chair Powell Wednesday afternoon we will want to focus on more. When Powell last spoke a few weeks ago, his comments were not as dovish as many expected. If tomorrow morning’s data suggest another upward revision to GDP expectations, odds are Powell’s comments, should he make any, are likely to skew less dovish yet again.
That brings us to the current market setup.
While neither the S&P 500 nor the Nasdaq Composite are overbought given their current relative strength index (RSI) levels, both market barometers have moved considerably since October 1 and are closer to overbought levels than not. Both also set fresh highs with Monday’s market close. Meanwhile, the short-term S&P Oscillator is flashing overbought, and as we discussed yesterday, the Citibank Panic/Euphoria model and the Fear & Greed Index, indicate headiness is alive and well in the stock market.
Once again, expectations are running high, and as we’ve seen in the past, it doesn’t take much to bring disappointment. We’ve seen that several times when it comes to the market's rate-cut expectations, and it looks like we may be seeing that again. Coming into today, the CME FedWatch Tool reflects the market seeing a 72% probability for a 25-basis point rate cut on December 18.
Ahead of tomorrow’s data, the question is this: Following a combined 75-basis points in rate cuts delivered at its last two policy meetings, if the economy is growing above 3% in the current quarter is the Fed inclined to take a policy pause later this month?
Indeed, should tomorrow’s data indicate the economy is growing at 3.2% or more in the current quarter, we could see rate cut expectations soften. A less dovish tone from Powell tomorrow or comments the Fed can take a measured approach to rate cuts would also lead to the market re-thinking the prospects of a December rate cut.
Prudent Portfolio Moves We’re Contemplating
The probabilities attached to the above are leading us to revisit positions in the portfolio. While we have none that are close to becoming outsized positions, we have two that are arguably extremely overbought.
Based on their respective RSI levels of 80.49 and 81.90, those two positions are Dutch Bros BROS and Elastic ESTC.
With Dutch Bros moving toward expanding its food menu, something that was a nice catalyst for Starbucks SBUX, and AI adoption in the enterprise still in relatively early stages, we will want to remain owners of both BROS and ESTC shares. Locking in some of their recent gains, however, would be a prudent move.
At the time of publication, TheStreet Pro Portfolio was long BROS and ESTC.
