Gill Capital Partners September 2024 Market Update
September 22nd marks the official first day of fall, and with it we welcome cooler nights, changing leaves and, this year, interest rate cuts. This week was probably the most heavily anticipated Federal Reserve Open Market Committee meeting that we can remember. Economists were fully expecting a rate cut but anxiously waiting to see how big of a rate cut we’d see and what guidance the Fed would provide regarding the future pace of rate cuts. The Federal Reserve cut interest rates by 50 basis points and provided clarity on the path of future cuts. More on this below, but first, an interesting reminder of how different the economic backdrop was last time the Federal Reserve cut interest rates.
The last time the Federal Reserve cut interest rates:
The rate cut was in response to the Covid-19 pandemic in March of 2020.
In their last scheduled meeting held on Jan 29, 2020, just weeks before the Covid-19 pandemic spread across the globe, the Federal Open Market Committee (FOMC) statement read, “Information received since the FOMC met in December indicates that the labor market remains strong, and that economic activity has been rising at a moderate rate.”
Shortly thereafter, as the Covid-19 pandemic spread, roughly 20.5 million jobs were shed in April 2020 alone and unemployment jumped to 14.7%.
The FOMC delivered two huge rate cuts at unscheduled emergency meetings in March, dropping the federal funds target rate to zero.
Between February 12th and March 23rd, the S&P 500 dropped 34%, with a single day drop of 12% on March 16th. This marked the second largest one-day decline on record, with Black Monday 1987 holding the number one spot with a single-day decline of 20.4%.
The economy was technically growing again by May of 2020 after the shortest recession on record.
Today’s backdrop could not be more different than the last time we experienced interest rate cuts.
The Federal Reserve Cuts Interest Rates
The FOMC lowered its key overnight borrowing rate by a half percentage point, or 50 basis points, amid signs that inflation is moderating towards its target and that the labor market is no longer contributing to inflation. This marked the first interest rate cut since the early days of the Covid-19 pandemic. Fed Chairman Jerome Powell said, “The Committee has gained greater confidence that inflation is moving sustainably toward two percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.” The decision lowers the federal funds rate to a range between 4.75% and 5%. In addition to this reduction, the committee indicated that we will likely see another half point in cuts by the end of the year, followed by a full percentage point of cuts by the end of 2025 and a half point in 2026. Chairman Jerome Powell said at his post-announcement news conference, “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with this inflation.” Furthermore, FOMC officials raised their expected unemployment rate this year to 4.4% from the 4% projection at the last meeting and lowered the inflation outlook to 2.3% from 2.6%.
Our view –There is a lot to unpack here! Yesterday’s Fed cut was highly anticipated, with the market basically split between a quarter and a half point rate cut. The Fed delivered the full half point, citing their belief that inflation is now comfortably under control and the labor market is softening. The Fed is looking to deliver the elusive “soft landing” and believes that a more aggressive cut now will stimulate the economy enough to thread the economic needle and keep the economy from slipping into recession. With equities at or near all-time highs and a recession seemingly nowhere in sight, some are scratching their heads as to why an interest rate cut is needed. Remember, the Fed’s job is to promote both stable prices (controlled inflation) and maximum employment. So, what is the Fed looking at exactly? Let’s start with inflation. Below is an updated chart showing the trend in annual inflation. Last month the year-over-year Consumer Price Index (CPI) came in at just 2.5%, down from over 9% in March of 2022.
The Federal Reserve’s inflation target is 2%, so while we are still a bit above their target, we are moving quickly towards it and there is good reason to believe that we will be there soon, or even drop below it. The Federal Reserve would very much like to avoid “deflation,” as that could very easily lead to an economic recession and potentially necessitate more aggressive rate cutting. Their goal is to engineer a reasonable level of economic growth without further inflation.
What about economic growth and jobs? What is the Federal Reserve seeing that justified a more aggressive interest rate cut? As shown in the charts below, job growth has started to slow in recent months and the unemployment rate has been trending higher.
Furthermore, other forward-looking indicators, such as flows into early delinquency (particularly across auto and credit card loans) have picked up meaningfully in recent months, a sign that borrowers are struggling to repay their debts and an early sign of economic weakness. It is clear when looking at economic indicators that the economy, while still growing, is showing signs of weakness. The Federal Reserve is integrating all of this into their decision-making framework on interest rates, and their decision to get ahead of softness in the economy makes sense.
What can investors expect from markets going forward?
With equities at or near all-time highs, bond yields coming down and cash yields at the highest levels in 20 years, what can investors expect going forward?
Our view – Lower interest rates have historically been good for stocks and bonds alike. The chart below illustrates historical asset class returns over the last 7 interest rate cycles following the first rate cut.
Stocks love lower interest rates. Frankly, it has amazed us just how well the stock market has managed through this period of restrictive monetary policy. Lower rates will benefit stocks in general, but historical correlations favor more interest rate-sensitive equities such as high growth, small-cap, international and emerging market equities. The last couple of years has seen a small handful of companies outperform dramatically; we would anticipate a broadening out of the equity market rally to include these more rate-sensitive sectors moving forward.
In bonds, we have already seen a significant rally in bond prices as interest rates have come down in anticipation of rate cuts. Historically, there have been more returns to come following the first rate cut.
Cash and money market yields will begin to drop following the first rate cut as banks will cut CD rates and money market portfolios will see yields drop as funds are reinvested at lower rates. Please reach out to us if you are sitting on cash and wondering what to do with it in this new environment.
It appears, at least for now, that the Federal Reserve is artfully and skillfully threading the economic needle with its goal of engineering a soft economic landing. Once thought of as an economic “unicorn,” the soft landing has come more into focus as of late. We know things can change quickly and, as always, we will be watching and will continue to communicate with you as needed.
Enjoy this early fall season and please do not hesitate to reach out to us with any questions about markets, the economy, or anything else we can help with.
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.