Fed's Surprise Rate Cut – What’s Really Going On?
September 18, 2024
In a surprising move, the Federal Reserve announced a 50 basis point (bps) reduction in the Fed Funds rate today. Market expectations were split between a 25 and 50 bps cut, but even a smaller reduction seemed unnecessary in my view, let alone a full 50 bps. The real surprise came during Fed Chair Jerome Powell's press conference, where he justified the cut by stating that the U.S. economy is in a "good place" and that the reduction was intended to "maintain this strength" by bringing rates down to a "normal level."
This reasoning left me puzzled. Powell is correct that the U.S. economy is in good shape. In Q2, GDP grew at a robust 3.0%, and the unemployment rate is currently 4.3%. There are no immediate signs of a recession, and while things could shift over the next few quarters, most analysts don’t foresee significant economic weakness on the horizon. For some context, the average annualized GDP growth over the past 77 years has been 3.19%, and the average unemployment rate 5.69%. These figures suggest the economy is performing well within historical norms.
Powell’s comment about returning the Fed Funds rate to a "normal level" also raises questions. Over the last 70 years, the average Fed Funds rate was 4.68%, and for the past 63 years, the average 10-year Treasury rate was 5.85%. As of yesterday, these were 5.5% and 3.65%, respectively. Inflation, too, has moderated to 2.5%, just 50 bps above the Fed's 2% target—a level far from signaling any major concerns.
With all these indicators pointing to an economy in good health, it’s difficult to understand the Fed’s decision to lower rates by 50 bps. Do they have insights into looming risks that the market isn’t fully aware of? One plausible conclusion is that the Fed is taking an accommodative stance toward financial markets. However, the yield curve tells a different story: the market is pricing in more aggressive cuts, anticipating over 200 bps of easing in the near future.
Regardless of the rationale, rate cuts tend to be bullish for equities, and today’s move should give stocks a boost. However, the yield curve remains inverted, so my recommendation on long-term bonds hasn’t changed – avoid them. Instead, focus on owning high-quality dividend growers and selectively add companies with strong earnings growth potential.
It’s an interesting time, and while the Fed’s move raises more questions than answers, it’s clear that staying nimble and selective in this market is key. My concern is that when the next economic crisis hits, whether in the U.S. or globally, will the Fed have enough ammunition left to combat it? By cutting rates now to accommodate capital markets, they may be depleting critical resources that could be needed for a more severe downturn.
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