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06/10/2024 Market Strategy

  • John Stoltzfus
  • June 10, 2024

To Cut or Not to Cut?

We don’t expect a rate change but the tone and substance of the FOMC report will be of import

Key Takeaways

  • We discuss the Fed’s progress in reducing inflation as the central bank meets this week.
  • Last week’s jobs report surprised to the upside but showed signs of softening, including a rise in the unemployment rate. The ISM surveys of business confidence were mixed, with manufacturers struggling while services firms saw a solid gain in activity.
  • The week ahead brings the first inflation indicators for May. The consumer price index is expected to rise just 0.1% while the median survey estimate for the core rate (excluding food and energy) is for a 0.3% rise from April.
  • The Federal Reserve meets on Tuesday and Wednesday and while a change in policy rates seems very unlikely, investors will be focused on tone and substance of its policy statement. 
fed building

The message that resounds today as much as when it was first uttered over 30 years ago, is “It’s the economy, stupid!”

Questions we get about government budget deficits, interest rates, monetary policy and the value ascribed to the markets as to what lies ahead are very similar whether we are meeting with institutional or private investors.

One thing that stands out in our conversations is a frustration that higher wages don’t always bring greater affordability for today’s lifestyles; instead people focus on the higher cost of just about everything and the risk that rising wages beget even higher prices.

Last week saw markets once again bounce between gains and losses in response to economic data released and discounted over the course of the week.

Quotation from Aenean Pretium

We believe the US economy is likely mid-cycle rather than late cycle as some project.

The S&P 500 closed lower on Friday as the jobs number exceeded expectations and unemployment notched higher to 4%—a threshold level that had for decades been taken to be indicative of full employment in the economy.

The economic data released last week supports our view that it is unlikely that the Fed will cut rates soon. In the same thought we also do not see the Fed likely raising rates based on data that proves just somewhat hotter than expected. Where rates stand today may indeed be the “new normal” until the inflation rate is reduced.

For now we expect the Fed to remain on pause, at least until late in the second half of this year—likely until after Election Day in November.

The inflation rate has been stuck since late 2023

While various price data show signs that inflation is slowing, it remains sticky enough to keep the Fed’s 2% inflation target elusive. Consider that year-over-year inflation measured by the Fed’s favorite gauge (the core deflator for personal consumption expenditures index, which excludes food and energy) has edged only slightly lower—moving from 2.9% last December to 2.8% in the latest reading for April.

For now, the timeless slogan “easy does it” appears to be the Fed’s best path in addressing the remaining stickiness to avoid triggering a recession.

Some market participants naturally remain concerned that the longer the Fed keeps monetary policy at current levels the greater is the risk for the economy to slip into a recession.

However, the Fed’s favorite inflation gauge hasn’t cooled as much as the central bankers would have liked so far this year. It’s heading in the right direction just not as fast as many would like.

Prices at the headline CPI level show pressures emanating from gas pumps, grocery stores, restaurants, rents, insurance and air fares remain stumbling blocks for business and consumers.

That said, in our view there is enough resilience reflected that remains persistent in business, the consumer and in job creation to suggest that the current environment remains navigable toward the Fed’s inflation goal. It continues to appear possible for the Fed to deliver a soft landing.

The potential for a soft landing or even just the avoidance of a recession in a somewhat bumpy touch down can foster considerable opportunity for investors to embrace the uncertainty, exercise patience, practice portfolio diversification and avoid knee jerk reactions to interim volatility that too often misses the signal for the noise generated in the process of moving toward normalization.

The good news in our view is that since the time that the Fed initiated the current rate hike cycle (March of 2022) it has remained remarkably sensitive in putting untoward levels of inflation in check without causing a recession (so far). Resilience is what’s likely underpinning the economy’s trajectory toward normalization. We believe the US economy is likely mid-cycle rather than late cycle as some suggest.

A soft landing is still possible

Demographics, better informed businesses and consumers, and technological innovation and prudent policy making by the Fed have seeded a level of sustainable economic growth— notwithstanding some 26 months of tight policy—without pushing the economy into recession.

It’s becoming increasingly likely in our view that when the Fed actually gets around to cutting interest rates it will be when it senses it can do so because the rate of inflation is close enough to its 2% inflation target to ease policy without risking an inflation blow back rather than from the economy being on the brink of recession or having fallen into recession.

Our expectations from the start of this year have looked for the Fed to cut in the second half with at least one cut of 25bps either in November or December (after election to avoid any questioning of the Fed’s independence by partisans). We could even see it cutting twice (25bps each) once in November and once in December if it felt it were prudent to do so.

For now we remain in the camp that expects the Fed to cut at least once (and perhaps even twice before the end of the year) so long as economic data in the months ahead signal that inflation is losing its stickiness at a pace that’s acceptable to the Fed. A rate cut of 25bps or even two cuts of 25bps each could serve as a “good faith deposit” by the Fed for Main Street and Wall Street to consider.

What might modest interest rate cuts by the Fed mean for the economy and investors midst a soft landing?

Lower borrowing costs should result in an increase in lending by banks, generate investment in the economy and move the needle on corporate revenue and earnings growth. It could help stabilize troubled segments in residential and commercial real estate. Modest rate cuts could also further broaden the rally in equities across sectors, among market capitalizations (large-cap, mid and small cap stocks) and style (growth and “growthier” value segments of the market.)

The tricky part for the Fed will be to not cut rates too much or too little whenever it does cut.

John Stoltzfus headshot

John Stoltzfus


Chief Investment Strategist, Oppenheimer Asset Management Inc.

John is one of the most popular faces around Oppenheimer: our clients have come to rely on his market recaps for timely analysis and a confident viewpoint on the road forward. He frequently lends his expertise to CNBC, Bloomberg, Fox Business, and other notable networks.

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