The FED Interest Rate Cut Mystery

The Fed finally caved to the market’s tantrum and cut interest rates by a half percentage point. This was the first cut since its rate-rising campaign that the Fed started in 2022.

Clearly something the Fed has seen since August has it worried, but just what is it and what can explain the rate logic here?

The market and especially the technology stocks got decimated in 2022, as they collapsed by 60%-80% when inflation reached unreported highs of over 100%.

After the massive Covid-19 induced stimulus surge and massive monetary easing, inflation left the Fed no choice but to pull the brakes and pull ’em hard. If it were not for the artificial intelligence rage of recent years, the market may never have made new highs at all.

Even though 2023 saw banks failing and hiccups in various asset classes, the market was held up by the broader large-cap technology names that make up about a third of the S&P 500 today. But that does not tell the whole story.

The economy is in dire straits as bankruptcies are rising, homes unable to be bought and credit cards maxed out as the U.S. consumer is in some serious pain now.

Today we are debating whether a 2% rate rise year-over-year is sustainable, but let’s not forget this is additive over the past three years of seeing inflation grow 10% year over year, so prices and the cost of living are in reality have doubled since Covid-19.

And look at the labor market, after the initial exuberance is showing signs of peaking as companies are not hiring anymore, and most are laying off. Banks are sitting on heavy losses marked to market covered at par by the Fed, but they are unable to lend.

So, the economy is screaming for rate cuts, it has been since the summer as every indicator of the U.S. economy is showing signs of rolling over, especially manufacturing and consumer related ones.

Thanks to services, the broader numbers are holding up, but that is also a reason why core consumer price index inflation around 2.6% is sticky. It is a two- tier economy and one policy will not suit all.

Today with markets at all-time highs and inflation close to target, but not really, one wonders why the Fed was so eager to cut by a half-percentage point and announce yet another half point in cuts in the next three months alone.

There is an old adage, when the Fed panics, the markets panic more.

Clearly something the Fed has seen since August has it worried. The Fed has been off-sides for months as the bond market has been trading. We are already in a recession as it is calling for two percentage points of cuts over the next two years.

Even though the Fed cut yesterday, it hardly changed its assumptions on the gross domestic product, consumer price index or unemployment as it is a mere 4.2% for the latter and CPI around 2.5%. So then why the rush?

The press call was extremely weak, as Fed Chair Powell did not do a good job explaining his motive at all. The past month’s revision of 800,000 jobs lower has the Fed convinced that perhaps the Bureau of Labor Statistics’ data is wrong and the labor market is a lot weaker.

Today there are two narratives. The equity market says we are in a soft landing and the Fed is cutting to jump start the economy as it bottoms. The bond market says we are already in a recession and the Fed cut is a bit too late.

So which one is right? You can not have a soft landing and the Fed stimulating as bonds are rallying, too, it just does not happen.

Powell suggested that the long-term neutral rate is closer to 2.9% and higher than pre-Covid-19. U.S. bonds are trading close to that level today 10 years out, which seems like there is little margin for error.

Something is amiss.

Investors are so used to using the old playbook with historical charts suggesting equities bottom after the first Fed cut that no one is even contemplating the scenario that we are already in a recession and that the market bottoms only after the last rate cut.

Take your pick. Trade wisely.

The Street Pro / ABC Flash Point News 2024.