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ECONOMIC UPDATE |
A Nugget of a Rate Cut! |
September 2024 |
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At the Jackson Hole Symposium in August, Federal Reserve Chair Powell made it clear that “the time has come for policy to adjust.” Thereafter, we got “Fed Speak”—the process whereby various federal reserve Presidents and Board of Governors publicly comment on their views on policy. These Fed talks are designed to provide rate direction to help traders adjust their expectations, thus reducing volatility in the market. Heading into Wednesday's FOMC meeting, there was no question whether the Fed would lower rates; the debate from Jackson Hole until now was not “if” but “by how much.” Most of the Fed Speak focused on a measured pace of lowering rates, and the consensus was for them to start out with a quarter point cut rather than a half point cut. However, the market wanted more, as indicated by the 50% probability indicated in the days leading up to September 18, and they got it. The Fed decided to lower its benchmark interest rate (Fed Funds) by 50 basis points, marking an aggressive start to a policy shift. |
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At the July meeting, the committee reincorporated employment back into its line of sight, rather than focusing solely on inflation. At this meeting, it was pointed out that the Fed’s two mandates—maximum employment and price stability—are now more balanced. So, why would they then move 50 basis points? During a lively Q&A session, Chair Powell defended the large cut, emphasizing that the economy remains strong, inflation has moved down, and employment is close to mandate. He added, “The economy is in good shape and so is the labor market, and we want to keep it that way.”
Powell's assessment aligns with the economic data, but these reports are backward-looking. Each Federal Reserve Bank gathers anecdotal information in its District and publishes a summary of economic activity and conditions eight times a year. The most recent report showed flat or declining economic activity in nine of the 12 districts, indicating a broad slowdown. Consumer spending ticked down in most districts, along with manufacturing activity.
Powell acknowledged that the labor market has softened, though it was overheated as the economy roared back following the pandemic. The Bureau of Labor Statistics (BLS) issues an establishment survey showing the number of jobs created, as well as a household survey providing unemployment data. Recently, BLS revised the job growth down 818K jobs from March 2023 to March 2024. This was nearly 30% less than initially reported and marked their biggest revision since 2009. The household survey showed negative job growth this year, and it tends to be more accurate.
Further concerning is the high level of consumer debt. Moving forward, we may see weaker economic conditions. According to the NY Fed, credit card and auto loan delinquencies hit 15-year highs in Q2, with 9% of credit card balances and 8% of auto loans more than 30 days late. With weaker consumer demand and a cooling labor market, something may be off with the economy, in contrast with Chairman Powell’s positive remarks. |
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The Pace and Magnitude of Cuts: |
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The pace and magnitude of future rate cuts will depend on whether the Fed can pull the economy into a soft landing or is forced to shift into recession-fighting mode. If the cuts come too quickly, inflation could reignite as they would make financial conditions looser. If cuts are too slow, they could weaken the economic situation.
The Statement of Economic Projects carried more weight at the meeting as FOMC participants recalibrated their beliefs on how the economy may evolve. The publication of the “dot plot” signals a slower pace of cuts over the next year, calling for another 50 basis points in cuts for the remainder of this year and 100 basis points for 2025. They revised other indicators, which are in the table below. The terminal rate (the longer-term target rate at which prices stabilize and full employment is achieved) has moved up, along with unemployment, from previous projections.
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Fed Funds |
Unemployment |
Inflation |
2024 |
4.4 |
4.4 |
2.3 |
2025 |
3.4 |
4.4 |
2.1 |
2026 |
2.9 |
4.3 |
2.0 |
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Although inflation has slowed, housing represents 35% of the index. Powell commented that “housing is one piece that is dragging.” He did believe that market rents have moved in the right direction, but lease renewals are not coming down as much. The issue with housing is supply, and it’s not something that the Fed can fix, nor is it a sector that can move quickly.
Since 2010, builders have started about 1.1 million new homes per year – far below the 1.6 million needed to keep up with population growth. The number of finished vacant lots available for building is 40% below the pre-Great Recession levels. Why? Zoning laws, tighter lending standards for homebuyers after the Great Recession, and builders are skittish as many overbuilt and had large losses in 2008. We did see a construction surge, hitting 1.8 million starts in 2022, but as interest rates increased, demand for new homes failed to rise, leading builders to cut back.
With too few housing units being built, home prices remain high. These high prices, combined with high mortgage rates, have created an affordability issue, leaving fewer qualified buyers in the market. If you can’t buy, you rent. While rents have eased in some areas, in most areas they have not. Existing housing supply is also an issue. According to Redfin, 78% of borrowers have a rate below 5% while almost 60% have a rate below 4%. Mortgage rates have decreased, but how much do they need to drop to get borrowers to move? That is the unknown. As rates drop, that might pull buyers back into the market but may not bring sellers to the market who don’t want to give up their historically low mortgage rates. With light inventory, housing prices will continue to increase. Given all these factors, this would mean that inflation may not reach 2% anytime soon. |
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….and would you pay $100 for a nugget? That is a chicken nugget! At the U.S. Open, you could get a box of six “golden” nuggets for $100. It was served with either Petrossian caviar with a dot of crème fraiche on top, or you can order it covered in black truffles and truffle mayo. Created by Michelin star restaurant Coqodaq, many enthusiasts were undeterred by the price. They sold roughly 100,000 handmade nuggets during the tournament. You may balk at the price, but that was a deal. At the restaurant six black gold nuggets will cost you $180. NYT, 9/9/24. |
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