Rate Cuts Begin

·   A 25- basis point fed funds rate cut happened in mid-September. 

·   Weakening employment data and better-than-expected inflation readings argue in favor of cuts. 

·   Resilient economic growth and tariff uncertainty argue against.

It appears to some, including The President, that the Fed is overdue in starting an interest-rating-cutting policy cycle in September.  Futures markets agree that policy change is coming, showing of additional 25- basis point cuts at future Fed Open Market Committee meetings.  But there are arguments, pros and cons, and it’s important to understand them.  After all, expected rate cuts are a big reason why stocks are at (or near) all-time highs.  And they will certainly be an important component of any new bull market leg. 

Let’s look at some reasons that would encourage the Fed to lower the policy rate:

The employment data is, at best, mixed but is tilting to the negative.  We had a couple of high -frequence readings recently.  The 4-week average for initial jobless claims recently hit a 4-month low.  That number is well behaved, remaining in the 200k-260k range.  But the trend in continuing claims is higher.  In addition, the big monthly Labor Department “non-farm payrolls” report has shown deceleration, markedly hit by negative revisions for May and June.  Combined, we have what’s known as a “no Hire/Nor fire” labor market. 

Why are these employment numbers so important to investors?  First and foremost, if employment softens significantly, it threatens the economic soft-landing scenario that has been the backbone of this bull market.  And the likelihood of a serious slowdown or recession is not currently built into stock prices. 

Inflation has been better behaved than expected, given the implication of tariffs.  Core PCE, the Fed’s preferred measure because it eliminates volatile food and energy, was +2.9% on a seasonally adjusted basis in July.  This number is above the Fed’s target of 2% but it is not evidence of the inflation spike that some analysts were expecting because of new tariffs and trade agreements.  As we enter September, many believe the better argument of the Fed is to support employment rather than be inflation hawks. 

Cuts would likely help the budget by reducing debt service.  The national debt is currently more the $37 trillion, and debt service is the 3^rd biggest government function at approximately $880 billion per year.  (behind Social Security at $1.51T and healthcare at $991B).  A Fed cut would likely drop debt service payments and the fed funds rate are an indirectly related, with factors such a maturing debt schedules and foreign demand, part of the mix.

Gross Domestic Product is above 3% right now.  We just received a revision from the Bureau of Economic Analysis for the 2nd Quarter, and it was a good one.  Looking ahead, as we go to press the Atlanta Fed’s GDP now estimates for the 3rd. Quarter growth is 3.5% (this reading can be volatile, but it’s the best we’ve got).   If is holds, that would be two consecutive strong quarters.  “I believe tailwinds from AI will continue to drive investments and fill cracks in the U.S. economy,” said Jared Franz Partner and Economist at Capital Group in a recent piece.

With economic growth in the mid-3s and corporate earnings holding up (we see 11-12% year-over-year growth in the just-finished quarter), is monetary stimulus necessary?

Stocks have already created a “wealth effect” that is, on its own, supportive of the economy.  This point comes courtesy of famed economist Ed Yardeni, in a note he shared with Market Watch.  Yardeni’s comments dovetail with our first reason arguing against Fed cuts (the economy doesn’t need it).  But he provides a special twist.  “We think the bull market is having a significant positive wealth effect on consumers who own equities,” says Yardeni.