The False Security of Jumbo Rate Cuts
By the Curmudgeon with Victor
Sperandeo
Backgrounder:
The Fed kicked off a rate
reduction cycle at its September 18, 2024, meeting, lowering the Federal Funds rate
by 50 bps to a target range of 4.75% to 5%. That was followed by 25bps rate
cuts in November and December. There have been no Fed rate cuts in 2025, but
one is surely coming in 10 days.
After Friday’s disappointing BLS
jobs report, several pundits are forecasting a 50-bps rate cut at the
conclusion of the September 17th FOMC meeting. Yet the CME
Fed Watch tool assigns only an 11% probability of that, with an 89%
probability of a 25 bps cut.
Despite President Donald Trump’s
repeated demands for jumbo Fed rate cuts, a 50-bps cut could be bad news for
the stock market. It could signal
that the U.S. economy is deteriorating faster than Wall Street analysts had
expected. That could lead to a recession with a significant decrease in
corporate profits (supposedly the main driver of stock prices). Such a perception would likely temper the
ongoing AI mania and lead to a downward shift in market sentiment. Also, lower
rates aren’t an immediate cure for an ailing job market.
The key factor is whether a big
Fed rate cut stabilizes the economy such that a recession is avoided. If it
comes too late, the economy could experience a severe, prolonged recession with
a worsening labor market, declining consumer spending, and financial market
instability.
Monetary policy works with long,
variable lags, so large rate cuts may not arrive in time to reverse economic
weakness, leading to larger job losses, reduced borrowing and economic
activity, and greater overall economic pain.
Jumbo Rate Cuts vs.
Economic Metrics:
Jonathan
Lansner examined the relationship between Fed Funds and key economic
variables over the past 40 years. The 480 months since 1985 were divided into
three groups by 12-month changes in Fed Funds.
When the Fed was most active – the 160 months with the most significant
rate cuts – Fed Funds dipped on average to 3.8% from 5.6% 12 months earlier.
That’s a 1.8% decrease. The Fed Funds rate is currently at 4.3%, which is 0.9%
above its 3.4% average since 1985.
To gauge the economic impact of
Fed rate cuts, Lansner evaluated how 10 economic metrics performed when the
central bank aggressively lowered its benchmark rate. The metrics were ranked
by how often they moved in tandem with Fed Funds.
Mortgage rates: Home loans typically get cheaper as the Fed’s
slashing of short-term rates reverberates to longer-maturity financing. The
30-year rate fell to an average of 7.4% in the 12-month periods with the most
extensive Fed cuts. That’s down from 8.1% in the previous 12 months but above
the 6.5% 40-year average. Such declines occurred 88% of the time following
significant Fed actions.
Business climate: It’s likely to be weaker as the Fed tries to
reverse business malaise. A Philadelphia Federal Reserve Bank index of U.S.
economic output shows 1.1% annual growth as large rate cuts get made, down from
2.7% in a year and a 2.7% 40-year average. This economic growth reduction
occurred 81% of the time.
Weak job market: Employment opportunities shrink. U.S. job counts
fell an average of 0.2% in the rate-slashing periods since 1985, compared with
1.4% gains in the previous year and a 1.3% annual hiring pace since 1985. Job
growth slipped 79% of the time.
Unemployment: When the Fed is actively lowering rates, U.S.
unemployment is usually rising. It averaged 6.3% after bold Fed actions, up
from 5.4% the preceding year, above the 5.8% norm. This increased joblessness
occurred 74% of the time.
Growing anxieties: Falling rates unnerve shoppers. Consumer confidence,
as measured by the Conference Board, dropped at a 14% annual rate following big
Fed cuts. Shoppers knew trouble was ahead, with confidence down 7% in the
preceding year. This optimism yardstick rose 2% annually since 1985 but dipped
67% of the time after big Fed cuts.
Rents: Landlords trimmed the rate of rent increases due
to the economic challenges. Rent nationwide, as measured by the Consumer Price
Index, rose an average 3.7% in a year after large Fed actions since 1985 vs. up
4.1% the year before and a 3.5% historic norm. Smaller rate hikes happened 63%
of the time when Fed Funds tumbled.
Inflation: Economic slowdowns often dampen
the cost of living because people have less money to spend. The overall CPI
rose just 2.6% in heavy rate-cut periods since 1985, down from 3.3% the
previous year and below the 2.8% 40-year norm. Decreased inflation occurred 63%
of the time.
Residential Real Estate: Price appreciation averaged 3.3% a year after noteworthy
Fed cuts, according to a federal home-price index. That’s down from 3.5% gains
the year before and the 4.8% 40-year pace. But note that such cooling occurred
only 38% of the time after big Fed cuts. So, the central bank’s pull on prices is unclear.
Homebuilding: When the Fed is cutting rates, building permits
are slumping. After the central bank acted, permits dipped at an average 3.1%
rate – but that was better than the 4.4% drops in the previous year. But note
this “improvement” in building permits direction occurred only 51% of the time
after significant Fed action. So, the central bank’s impact on new home
construction is basically a toss-up.
Stock Market: The S&P 500 stock index rose at an average
5.8% annual rate following big Fed moves vs. a 10.4% 40-year average total
return. However, the S&P 500 had
negative one-year returns after a 50bps Fed rate cut in 2001 and 2007. In 2001,
following the Dot-com bubble, the S&P 500 dropped 14.9% in the year after
the Fed's first rate cut. During the 2007-2009 Global Financial Crisis, the
market fell over 27% in the year following the Fed's initial 2007 rate cut. Therefore, big Fed Fund rate reductions
haven’t been a good predictor of future equity market returns.
Victor’s Comments:
The economy is far weaker than
advertised, as our esteemed colleague Lacy Hunt has been saying for months now.
As a result, I expect a 50-bps cut in Fed Funds to be announced on September 17th. The highly correlated 2-year note yield of
3.51%, which usually mirrors the Fed Funds rate, implies there should be a
100bps cut. Politically, that is not going to happen.
The CPI comes out this Thursday,
September 11th and “IF” reported accurately by the BLS it will be in
the low 2% range. Prices of homes and rents are declining rapidly, but the
“homeowners equivalent rent” (approximately 40% of the CPI) may not be adjusted
as of next week but will in the future. Inflation and short-term interest rates
will be coming down.
The “TRUFLATION” rate was 2.02% Friday - down from
over 3.1% in January.
Although mortgage rates and U.S.
long bonds dropped significantly after the bad jobs report on Friday, that
might not happen again until we see conclusive proof of a recession. An economic slowdown is now upon us, but it’s
discounted to a large degree.
The U.S. stock market is topping,
with the public being the biggest buyers on the rally from April 9th. I plan to short the
S&P 500 futures AFTER the rate cut on the 17th. I also plan to sell the 5-year T-note futures
I purchased earlier this year.
End Quote:
Keep in mind the wisdom of H.L.
Mencken:
“Nobody ever went broke underestimating
the intelligence of the American people.”
Henry Louis Mencken (September 12, 1880 – January 29, 1956) was an
American journalist, essayist, satirist, cultural critic, and scholar of
American English. He commented widely on the social scene, literature, music,
prominent politicians, and contemporary movements.
….…………………………………………………………………………………………………………………………..
Wishing you good health,
success and good luck. Till next time……
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
Copyright © 2025 by the Curmudgeon and Marc Sexton. All rights reserved.
Readers are PROHIBITED from duplicating, copying, or reproducing article(s) written by The Curmudgeon and Victor Sperandeo without providing the URL of the original posted article(s).