Rate Cuts: Good News, Bad News

As reported yesterday, the Fed cut interest rates for the first time in over four years. But that was expected. What wasn't expected by many was how aggressive the cut was. And that's the bad news for markets and the economy.

Why? Weren't market bulls hoping for a pivot by the Fed for months? Weren't they ready to pop the champagne cork?

First, let's recap what happened yesterday...

The Fed cut the fed funds rate by 0.50%. But this large cut will not have any stimulative effect on the economy.

Here's the text of part of the Fed's press release issued at 2:00 pm ET yesterday:

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the long run. The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate. In light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5 percent. In considering additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgagebacked securities. The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective.

The FOMC vote on this policy statement was 11-1 in favor. One governor, Michelle W. Bowman, voted against the 0.50% rate cut; she favored a 0.25% cut. That was the first dissenting vote by a governor since 2005.

This meeting included the "dots," technically the Summary of Economic Projections (SEP) offered by 19 Fed governors and regional reserve bank presidents and presented in graphical form as a dot plot. The dots show individual forecasts of key variables such as unemployment, interest rates, inflation, and economic growth.

The dots do not deserve serious attention as forecasting tools. The Fed has the worst forecasting record of almost any institution. That said, the dots do show an expectation of further rate cuts between now and the end of the year coming at the Fed's meetings in November and December.

Here's a summary of the SEP dots disclosed at this meeting: The median forecast for GDP growth is 2.0% for the next two years, a rate that Powell described as "solid." The median inflation projection is 2.3% for 2024 and 2.1% for 2025. The participants expect inflation to level off at 2.0% (the Fed's goal) for 2026 and thereafter.

The projected fed funds target rate is 4.4% as of December 31, 2024, and 3.4% as of December 31, 2025. The peak in the unemployment rate for this cycle is 4.4%. As noted, all these projections should be taken with more than a grain of salt. The Fed's forecasting record is abysmal.

Powell Paints a Rosy Picture, But...

The statement release was followed at 2:30 pm ET by a press conference with Fed Chair Jay Powell.

Powell noted that in addition to the fed funds target rate cut, "we also decided to continue to reduce our securities holdings" and that "we're not thinking about stopping the runoff" of balance sheet assets. That's a bit odd because rates cuts are a sign of monetary ease while balance sheet reductions are a sign of monetary tightening. Powell defended doing both at the same time by saying they both amounted to "normalization" relative to prior conditions. In effect, the Fed is trying to get out of both the stimulus business and the inflation fighting business and get back to a less interventionist posture, something not seen since 2006. Good luck with that.

Regarding the shift in concern from inflation to unemployment, Powell admitted, "the downside risks of employment have increased." At the same time, he defended the Fed's policies to date by saying, "We don't think we're behind ... but you can take this [rate cut] as a sign of our commitment not to get behind." He doubled down on this sentiment by saying, "The U.S. economy is in a solid place and the purpose of our decision is to keep it there."

Those are brave words, but they're substantially undercut by the fact that the Fed moved to cut rates 50 basis points, not 25. That certainly suggests the Fed is already "behind." It also suggests the U.S. economy is not in a "solid place." The history of Federal Reserve policy is that they are always behind the curve as they were in the Great Depression, the 1970s inflation, and again in the 2008 financial panic. We don't have to assume conditions today are as bad as those three episodes (although they could be headed that way) to conclude that the Fed is behind the curve again.

The decision to cut interest rates at all is a clear signal that the Fed has pivoted from concerns about inflation to concerns about unemployment and, by implication, fear of an emerging recession. That's why we describe this move as a double pivot. It's a pivot from higher rates to lower rates and it's a pivot from one part of the Fed's dual mandate - inflation - to the other part - unemployment. That much is clear. What is less clear to most observers is that the decision to go with a 0.50% rather than 0.25% rate cut is a sign that the economy is worse than most realize.

The inflation part of the dual mandate is indeed showing progress. After a long period of stubbornly high inflation, the inflation news has been positive for the Fed in recent months. Here's the tale of the inflation tape using the Consumer Price Index on a year-over year basis:

DateCPI (year-over-year)March 20243.5%April 20243.4%May 20243.3%June 20243.0%July 20242.9%August 20242.5%

(The CPI data for September 2024 will be released on October 10. There is no FOMC meeting in October).

That's the kind of persistent movement toward a policy goal sustained over more than a few months that the Fed likes to see.

As for the unemployment part of the dual mandate, Powell takes comfort from the fact that the unemployment rate is still only 4.2%, which is low historically. However, that's a steep increase from the 3.8% level that prevailed this time last year. Other employment data including the alternate household survey (in contrast to the employer survey of employment) has been much weaker in terms of job creation over the past year.

Most of the reported job creation in both surveys has been with part-time rather than full-time jobs. Almost all the job creation has gone to illegal immigrants at rock bottom wages. That's not exactly the kind of jobs market that can sustain the U.S. economy as Powell envisions.

Oil prices have plunged from $94.00 to $69.00 per barrel over the past year even as consumer savings are depleted, credit cards are maxxed-out, and flattening yield curves (with short-term rates plunging more that the Fed rate cuts) are all signs of a weak economy and coming recession. The conclusion is unavoidable that the Fed is behind the curve and hard times are on the way. Rate cuts won't help.

Stock markets rallied briefly after the Fed announcement but ended up slightly lower on the day yesterday. The Dow Jones, S&P 500 and NASDAQ Composite were each down about 0.30% at the close. This could be a case of "buy the rumor, sell the news."

Gold was up over $31.00 per ounce to $2,625 per ounce intra-day, a new all-time high after the Fed's announcement. The price then backed off a bit to the $2,575 per ounce level, down slightly on the day.

The next Fed meeting is November 6-7 (right after the election) and the final meeting for the year is scheduled for December 17-18. We can safely predict the Fed will cut rates further at both meetings. Whether those cuts are 0.50% or 0.25% each remains to be seen. What we can be sure of is that it will be too little, too late to save the economy from recession.

The market put the champagne back on ice for now.