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Interest Rate Haircut




A lot has happened since our last issue, so let’s dive right in and see where we are….

 

1.Equity markets have recovered most of the losses from late July and early August.

 

2) Concerns about labor weakness, recession, and the yen carry trade have lessened somewhat as we’ve gained some clarity on Fed policy as they have started to cut rates.

 

3) The historically elusive “soft landing” economic scenario that we have been forecasting for almost two years remains in place.

 

We’ve talked about the concept of an economic soft landing many times.  Loosely defined, the economy achieves a soft landing if it slows (allowing inflation to decline) but doesn’t slow enough to fall into recession.  As you know, growth has been slower through the first three quarters of this year compared to the last half of 2023.  We have even seen recent estimates for 3rd Quarter 2024 growth in the 1.5%-2.0% range, somewhat lower than the current Atlanta Fed projection.  While the economy has been slowing, the trend in the 12-month inflation rate has declined substantially. 

 

But the Fed’s fight against inflation isn’t finished.  A recent PCE reading of 2.6% shows work still needs to be done (remember, the Fed’s target is 2).  However, Chair Powell told the world at the Jackson Hole symposium that “the time has come” for lower interest rates.  The Fed’s tough monetary policy (11 hikes totaling 525 basis points), which began in March of 2022, has accomplished enough on the inflation front for the Fed to charge direction. 

 

This is important for an economy that has recently shown weakness in the labor market.  


The unemployment rate has trended up from 3.4% in August of 2023 to 4.3% in July 2024.  Just a few weeks ago, it was the July jobs report that added to recession fears and pushed stocks lower in early August.  Keep in mind, however that the Fed needed a bump in unemployment to help with their battle against inflation.

 

While we are optimistic regarding Fed policy and the soft landing, there are other risks to the economy and markets.  There is no shortage of geological risk that can flare up at any time (in the Middle East, Ukraine, and Taiwan for example).  The November elections could potentially rile the markets too, although we track these things closely and currently the most likely result is the continuation of a divided US government.  Policy gridlock is generally good for stocks.

 

These risks are real, but not unusually high.  With favorable interest rate policy and a durable economy, our outlook over the next six to nine months is positive for stock and bonds.  You should maintain your asset allocation

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