The Big Picture
In The Big Picture column posted last week discussing inflation trends and their meaning for the Fed, we concluded with an expectation that the Fed will be buying what the market is selling.
What was the market selling? A rate cut at the September FOMC meeting.
The speech Fed Chair Powell gave at the Jackson Hole Economic Symposium was titled Review and Outlook. It could just as easily have been titled Sold!
The Time Has Come
Fed Chair Powell is not one to make specific promises when it comes to monetary policy settings. The refrain for some time is that the Fed is data dependent and will make decisions on a meeting-by-meeting basis.
In his Jackson Hole speech, however, he came about as close as ever to making an explicit statement that the Fed is going to cut rates in September.
And we quote:
"The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."
Those two sentences packed a lot of implicit punch.
The first sentence is the nod to a September rate cut. The second sentence is arguably the more important of the two. It left an impression that there won't be just one rate cut; moreover, it also left the door open for a policy adjustment that could exceed 25 basis points.
That won't be the case at the September meeting, but beyond that, a 50-basis points adjustment could be seen. That isn't a promise. Rather, it is an implicit possibility.
It sounds as if the labor market will be calling the shots on any 50-basis points adjustment. Fed Chair Powell noted that, "We do not seek or welcome further cooling in labor market conditions."
That's a jarring statement with the unemployment rate still at a relatively low 4.3%, yet we suspect the rate of change in the unemployment rate (up almost a full percentage point above its level in early 2023, with most of that increase coming over the past six months) is what has caught the Fed's concerned eye.
It is also worth noting that a 4.3% unemployment rate is above the Fed's longer run median estimate of 4.2% seen in the Summary of Economic Projections provided in June.
A New Way of Thinking
Something else we think the Jackson Hole speech accomplished is that it likely altered the market's handicapping of incoming economic data.
Not long ago, the fulcrum of economic reporting was whether a certain data point meant the Fed was going to cut 25 basis points or not at all. But since the "direction of travel is clear," the market will adjust its thinking to ponder whether a certain data point means the Fed is going to lower the target range for the fed funds rate by 25 basis points or 50 basis points.
The CME FedWatch Tool shows the fed funds futures market is expecting the target range for the fed funds rate (currently 5.25-5.50%) to be cut by 100 basis points before the end of the year to 4.25-4.50%. There are only three scheduled meetings left this year, so it is implied that one of those three meetings will produce a 50-basis points rate cut.
Currently, the November 6-7 meeting, which ends two days after the election, is the odds-on favorite with a 59.2% probability of a 50-basis points rate cut. That is up from 47.1% the day before Fed Chair Powell gave his Jackson Hole speech.
What It All Means
The market was pleased by what it heard from Fed Chair Powell. It has been hanging its rally hat on the idea that rate cuts are coming and that the U.S. economy can avoid a hard landing.
That is a Goldilocks step down from a tightening campaign that began in March 2022 and peaked in July 2023. In total, there were 12 rate hikes over that period that raised the target range for the fed funds rate by 525 basis points.
It hasn't been a painless process for the economy but, remarkably, the pain of those rate hikes in a broad economic sense has been tolerable.
With the Fed now looking to travel in a new direction with its policy setting, there is some abiding hope that it will escape its tightening campaign without killing the economic expansion.
If one wants to catch a glimpse of the market's confidence in that outcome, watch the small-cap stocks and the value stocks. They stand to gain the most in our estimation from the Fed lowering rates because inflation trends are improving and not because the economy is coming off the rails.
Dividend-paying stocks will be another beneficiary in a lower interest rate environment, so they are seemingly well positioned, along with bonds, for a policy road ahead that is being managed in conjunction with a soft landing.
Should the economy take a hard landing turn for the worse, the playbook will change. In that situation, one could expect to see the mega-cap and large-cap stocks as relative strength leaders, and growth being favored over value. Since a downturn for the economy would ultimately invite more policy easing, higher quality dividend-paying stocks and bonds would also be poised to exhibit relative strength.
A hard landing or recession, though, isn't good for stocks in general since that would lead to a downturn in corporate earnings.
That isn't in the Fed's outlook, and with the S&P 500 flirting with all-time highs amid a broadening out in buying efforts, it is fair to say that it isn't the market's prevailing outlook either. The market seems to be relishing that thought now that the time has come for policy to adjust.
