It was probably only interesting to financial geeks, but for the couple days going into last week’s FOMC meeting there was a real tug-of-war going on between “economists” and the market.
Since the beginning of the year, there had been expectations of interest rate cuts starting in March. Last December, the Fed itself was projecting nearly 100 basis points over 2024.
But then CPI got stuck at 3.5%. (Even the notoriously Fed-friendly PCE was rising 2.7% year-over-year.)
The party had to be postponed.
And after standing pat for a handful of meetings, convincing itself that they really had the inflation beast under control, the Fed finally saw its destiny in the jobs reports over July and August.
Back-to-back misses and downward revisions to nonfarm payroll numbers (which had been building all along) along with an uptick in the unemployment rate shifted their focus. (Or at least their talking points.)
At the Fed’s annual Jackson Hole Symposium, the three day get-together of central bankers and other elite types from around the world to discuss the fate of interest rates, Chairman Powell said the following:
Overall, the economy continues to grow at a solid pace. But the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate.
The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.
There was no mistaking what he was saying. So by the time the September meeting rolled around, it was game on for the long awaited cuts. The question wasn’t “if” anymore, but “how much?”
On opening day of last week’s FOMC meeting, the market was all-in pricing in a 64% likelihood of a 50 basis point cut.
“Economists” on the other hand, (105 out of 114 surveyed) were insisting that the Fed would only go 25 bps.
And as the clock struck 2:00PM ET, the Fed dropped the bomb…
50 bps it was.
And after receiving what everyone thought would be the best news possible, the market went haywire and ended up lower on the day…
S&P 500 (5 min)
So What Does All This Mean?
First, it means “economists” aren’t that smart.
Second, it means the Fed is likely more worried about the economy than they’re letting on. The Fed’s rate cut logic goes something like this…
While they’re straining their shoulders to pat themselves on the back for taming inflation, they still insist the economy is doing just fine. So they need to move rates from “restrictive” to “neutral” now, before things do start to slow down and the economy falls into a recession. Thus engineering the mythical “soft landing.”
Let’s break that down…
According to Powell, things are humming right along as even with a Fed rate target of 5.25-5.50%.
On top of that, asset prices (stocks, housing, etc.) at all time highs.
And unemployment estimates are well within the 4% range, a range Powell himself insists is perfectly healthy.
So why cut 50 points now? Why not just 25?
According to JP: they’re trying to get out ahead of a potential economic slowdown by starting to move rates to “neutral” now. (I put neutral in quotes because even according to Powell almighty, the Fed has no idea what neutral is. Like pornography, they’ll know it when they see it!)
The reality is the Fed is completely incapable of predicting anything. I give you their “inflation is transitory” claim from three years ago as proof.
The Fed is easing because of meaning number three: they know the economy is in worse shape than their numbers let on.
They know (and now we do) that the BLS overstated jobs added by over 800,000 over the past year.
They know the unemployment number will only keep rising thanks to the millions of immigrants who’ve crossed the border over the past three years — a fact that Powell copped to in his Q&A.
They know that consumers (who represent over 60% of GDP) are getting crushed.
And they know the economy is hopelessly addicted to cheap money.
So 50 bps it was. (Anything bigger would have incited a panic.) And you can look for at least 50 more by the end of the year.
Longer term, the reality is cheaper money will always inflate benefit asset prices. Period.
That said, a 50 bp cut doesn’t equal “cheap” money.
The real question is how committed are they to trying to find “neutral.”
Because should inflation reheat with unemployment still on the rise, Powell and Co are going to find themselves in the unenviable position of floating up S#!% creek.
Exciting times ahead…