The Federal Reserve finally pulled its monetary trigger, dropping the fed funds rate by an aggressive 0.50% on September 18th, bringing its current target range to 4.75% - 5.00%. In its policy statement, the FOMC (Federal Open Market Committee) said that its decision was the result of progress on inflation and the balance of risks. Economic activity has continued to expand at a solid pace, job gains have slowed, and the unemployment rate has moved up, but remains low, the statement read. The FOMC meets two more times this year and current estimates are for additional cuts that could lower rates another ½ percent by year-end to a range of 4.25%-4.50%, depending on the data the Fed is monitoring. The FOMC’s SEP (Summary of Economic Projections) “dot plot” puts the fed funds rate at 3.25% - 3.50% by year-end 2025.
The Fed’s action created delight for some and angst for others as they argued for and against the rate reduction. Those supporting an aggressive rate cut believe the Fed has been too patient for too long, inviting a recession. They argue the policy rate is still too high relative to the inflation rate and more cuts are needed soon. The opposite camp believes the Fed is being too aggressive and should have held firm or only cut the rate by 0.25%. They point to a strong economy, robust corporate earnings, an inflation rate that is still above the Fed's 2.0% target, and stock prices at record highs. They worry that the Fed could reignite inflation by easing credit too much, too soon.
It doesn’t really matter what the pundits think, because the market will sort it all out. In the wake of the rate cut, equity and bond prices rallied, and market interest rates fell. Investors apparently believe the Fed is being appropriately aggressive and pro-active in its efforts to navigate a soft-landing. While still slightly above the Fed’s 2% target, inflation has moderated substantially from the COVID-era highs caused by severe supply and demand imbalances. Inflation, as measured by the CPI (Consumer Price Index), rose by 0.2% in July, the latest data available, and by 2.5% over the prior twelve months as reported by the U.S. Bureau of Labor Statistics.
The economy, while slowing in certain areas, remains strong as evidenced by GDP (Gross Domestic Product). Real GPD (after inflation) increased at an annual rate of 3.0 percent in the second quarter of 2024, according to the "third" and final estimate released by the U.S. Bureau of Economic Analysis on September 26. This was up from the first quarter, during which real GDP increased 1.6 percent annualized. New home sales fell 716,000 in August, but the three-month average rose to its highest level since early 2022. Mortgage refinancings also hit the highest level since early 2022 and as homeowners refinance, they will have more discretionary income to spend. The unemployment rate was 4.2% in August compared with 3.8% in August of 2023, but still below the 5.69% average from 1948 – 2024 according to Trading Economics.
Equities posted impressive gains during the third quarter and year-to-date as investors maintained a risk-on posture in the face of falling interest rates. However, corporate earnings estimates have been declining according to FactSet and Federated Hermes. Per share estimates for the third quarter are currently expected to increase 3.7% year-over-year, less than half the 7.8% y/y gains estimated at the start of the quarter. Retail spending is under pressure as evidenced by back-to-school (BTS) spending, which was up a modest 2% during the June-August period, the lowest increase in 15 years. The BTS season is four months long and September’s data is not yet available, but confronting continued rising costs, a softening labor market, and decreasing consumer confidence, consumers are pulling in the reigns and increasing their personal savings.
Interest rates, which hit cyclical highs earlier this year, have fallen and the yield curve is becoming less inverted as market participants see evidence the Fed’s monetary policy is starting to produce fruit. By 09/30/24, the 10-year U.S. Treasury note yielded 3.78%, down from 4.71% in May of this year. The 2-Year UST note, which yielded 5.05% in May, dropped to 3.65% at quarter-end. Falling interest rates are a two-edged sword. Reduced borrowing costs make durable goods more affordable and raise the probability that some homeowners will refinance their debt. This is certainly the hope of the Federal Reserve as it attempts to negotiate a soft-landing. Unfortunately, for fixed-income investors, lower rates mean lower yields from their “safe” assets. However, returns from their equity holdings should help offset those lower yields, as over time equities typically perform well in low-interest rate environments.
Markets typically don’t like uncertainty, of which 2024 has been chock-full, but so far this year, investors who ignored uncertainties garnered handsome returns from equities and bonds. Election uncertainty is increasing volatility as both Presidential candidates pose different risks to the economy. Geo-political risks are expanding in Eastern Europe and the Middle-East. The Fed’s policies may or may not be successful in its efforts to throttle inflation without creating a recession.
While few people embrace uncertainty, for goals-based, plan-driven investors, ever-present uncertainties are not an obsession or a barrier to success. These investors acknowledge risks but do not allow fear to goad them into taking impulsive actions. Nor do they become frozen into inaction from not knowing what to do. They often partner with dedicated, experienced professionals to create intelligent financial plans and prudent investment strategies in an effort to pursue reasonable outcomes at reduced costs, and without unnecessary risks. They try to maintain a financial discipline and clear focus to keep moving forward with a “steady-as-she-goes” progress. While waters may be uncharted, they remain navigable.
Stay the course.
Sam Taylor, CIMA®, AIF®, CRPC®