Looking at: The Fed’s September Statement

Estimated reading time: 3 minutes

First and 50

It’s been 301 days since the last rate move by the Federal Open Market Committee (FOMC), and the wait is finally over. The Federal Reserve cut rates for the first time in this cycle today, and by 50bps no less, bringing the federal fund rate’s upper bound down to 5.0% from 5.5%. This was the first meeting since July 2022 where markets were unsure about what the size of the rate move might be, which made the announcement even more closely watched.

The main reasons Fed Chair Jerome Powell stated as the reasoning for moving 50bps (rather than 25bps) were that the committee now feels confident inflation is sustainably moving toward its 2% goal, and that a move of this size puts the labor market in a better position to remain strong.

We buy that argument. Before this meeting, we stated publicly that the risk of cutting by 25bps and ending up way behind was bigger than the risk of cutting by 50bps and having to manage expectations for the pace of future cuts.

One way to manage expectations is the fed dot plot, which shows where each member of the FOMC believes rates should be at the end of each year. Currently, the Fed is projecting two more cuts by the end of this year, while the market is expecting three more.

Much like the market, we’ll take the over on the number of cuts the Fed is projecting, mostly because they are clearly more focused on labor market data than inflation data and we expect the labor market to cool further as the year progresses.

The title of this column is “First and 50”, and for the football fans out there, we know that first down and 50 yards is very far from the goal line. Although we think today’s 50bp cut set us up with a better chance of the economy remaining stable than a 25bp cut would have, we’re still far from finishing the game.

Turnover

The tone of this game has changed, from paused to cutting, from hot to cooling, from tight to balanced, and from inflation to jobs. That calls for a change in market tone as well, which has swelled with conviction of late despite already being in place for much of 2024.

The best performing sectors in the S&P 500 over the last three months are Real Estate, Utilities, Financials, and Consumer Staples. Technology and Communication Services take the last two spots over that same period, and are the only two sectors with a negative return. The more defensive parts of the market and the rate-sensitive sectors have won out, and we would expect that trend to continue… albeit not in a straight line.

Part of the reason for this is the change in economic data and projections. Every quarter, the Fed publishes their own projections of the major data points and this quarter’s update showed sizable changes.

In summary, the Fed’s projections for GDP and inflation came down, unemployment went up, and their expectations for where the fed funds rate will end the year came way down. That sends a broad message that they see the downside risks to the economy as increasing, and are willing to cut rates more aggressively in response in order to protect their dual mandate (stable prices and maximum employment).

Although we could also look at this as data that supports a soft landing, the overarching tone of this move was that it was an “insurance cut”, which tells me the Fed is focused on protecting the situation. More explicitly, Powell noted that “downside risks to employment have increased.”

A sobering chart is below, showing the relationship between the unemployment rate and rate cutting cycles. The takeaway is clear, unemployment typically rises quite dramatically when the Fed is cutting rates. There have been a couple times when this didn’t happen (1984 and 1995), but those were periods of a strengthening labor market, not a weakening one.

Sometimes it’s different, but most of the time it’s not.

Powell Playing for the Win

We was calling for a 50bp cut today, but we was skeptical that they’d have the guts to do it. We admit we are pleasantly surprised, and frankly proud of the Fed for going big and not being afraid of what it might do to markets. Powell is clearly trying to achieve a win and not taking the safe route. We applaud that.

But now the tug-of-war begins between what typically happens in this environment – economic contraction – and what investors want to happen – a soft landing. More often than not, the typical pattern persists, but soft landings have been achieved before. We believe we will see a weaker economy than many are hoping for, but we’re open to being proven wrong.

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