It’s not how you start, but it’s how you finish.
“He’s supposed to do that triple twist… sometimes a tough one to land though,” remarked the NBC commentators just ahead of the Philippines’ Carlos Yulo’s final gold medal vault jump at this summer’s Paris Olympics. Despite a somewhat wobbly landing as he struggled to stabilize the forceful inertia of his powerful jump and multiple aerial twists, he narrowly maintained sufficient balance to secure the victory.
After lowering its policy rate for the first time in more than four years by 50 basis points on September 19, the Federal Reserve is embarking on a similar challenge to smoothly balance a US economy that has been pulled and turned in multiple directions. Through emergency rate cuts in 2020 (as well as other monetary relief measures) to stave off deflation and then spiking rates dramatically in 2022 and 2023 to combat multi-decade high inflation, the central bank now confronts the final and perhaps most challenging part of the routine: sticking the landing.
The Fed has long stated that 2% is its long-term inflation target. In August, consumer prices had slowed but were still growing at 2.5%. So why did the Fed decide to cut rates before reaching its goal? Famed Nobel laureate economist Milton Friedman originated the idea in his book A Program for Monetary Stability that “monetary changes have their effect only after a considerable lag and over a long period” and that such lags could be “rather variable.” He estimated that the time period between monetary policy action and its economic effect could range between four and 29 months with little predictability within that range.
On that basis, waiting for inflation to get to 2% before reducing the policy rate would likely result in the Federal Reserve being late in its response, a point that Fed Chair Jerome Powell has stated repeatedly in the past.
Consequently, when the unemployment rate quickly rose from 3.8% to 4.3% between March and July and nonfarm payrolls were revised down by 818,000 by the Labor Department in August, many investors and economists alike became concerned the Fed was already late. This contributed to its decision to more aggressively cut the policy rate by 50bps instead of 25bps.
Furthermore, the rapid rise in unemployment also ignited worries about the Sahm Rule (named after macroeconomist, Claudia Sahm), a recession indicator that is triggered when the three-month moving average of the US unemployment rate increases by 0.5% or more from the previous 12 months.
Interestingly, though, Claudia Sahm herself published an article in August entitled, My Recession Rule Was Meant to Be Broken and said the US is not in a recession— admitting that many traditional economic tools are being “skewed by the unusual disruptions of the past four and a half years.” She commented that the level of unemployment is less important than the rate of its change and that “the Sahm Rule relies on a powerful feedback loop: Relatively small increases in the unemployment rate can turn into large ones.”
While this can be true, it doesn’t appear to be the case for now. Following sluggish job growth during the summer, September’s jobs report unexpectedly surged as nonfarm payrolls increased by 254,000. Additionally, US job openings also rose back above 8 million and wage growth has risen back to 4% from 3.6% in July, both signs that the job market remains quite robust.
In addition to good jobs data, US consumer spending is also healthy. In Deloitte’s ConsumerSignals report, financial sentiment among middle and lower income households has stayed flat over the last two years but financial sentiment for the higher income households continues to rise. This was supported by surprisingly strong retail sales over the summer that showed overall spending is still resilient.
It comes as little surprise, then, that with the backdrop of a generally strong US consumer, expectations are also high for overall economic growth. Both the Federal Reserve Bank of Philadelphia and the Federal Reserve Bank of Atlanta forecast US GDP growth of 2.5% and 2.6%, respectively, well outside of recessionary territory.
US stocks are certainly not pricing in a recession either. At a 21x forward price-to-earnings multiple, stocks are priced at some of their highest levels since the last 40 years. Furthermore, those multiples are applied to strong earnings expectations. For 2024, analysts are forecasting 10% earnings growth and even faster earnings growth of 15% next year.
This year the S&P 500 notched its best first nine months of a year since 1997. But according to The Wall Street Journal, corporate insiders have been reluctant to buy into the rally. Berkshire Hathaway, led by Warren Buffett, for instance, has built up a cash position of $277bn as of the end of June, up from $105bn just two years ago. Jeff Bezos of Amazon and Mark Zuckerberg of Meta have both sold billions of dollars of company stock this year. In fact, for 2024, stock purchases by company insiders through the first three quarters of the year are at their lowest level in 10 years. This is quite striking when considering that the S&P 500 is worth more than three times what it was at this same time in 2014.
Further complicating the macroeconomic picture are escalating tensions in the Middle East. It’s been almost precisely a year since the Oct. 7 Hamas attacks on Israel. Nevertheless, oil prices are lower today than 12 months ago as the US and other countries increased production and China’s slowing economy reduced demand. But with Iran’s recent missile attack on Israel, oil prices registered their largest weekly gain in over a year. According to The New York Times, the greatest risk to oil is if Tehran blocks access to the Strait of Hormuz, which connects the Persian Gulf to the Arabian Sea and accounts for passage of 20% of the world’s oil. Such an event could have a stagflationary effect by stirring inflation while simultaneously causing supply shortages and higher input costs that would restrict growth.
The other factor that could also drive oil higher is a potential economic recovery in China. On September 24th, for the first time since 2008 and for the first time under Xi Jinping, the People’s Bank of China (PBOC) announced a stimulus package that included cutting interest rates, lowering bank reserve requirements, and reducing the cost of existing mortgages. Additional stock-boosting measures include enabling Chinese companies to buy back their own shares via refinancing bank loans and allowing funds, insurers, and brokers to use riskier assets as collateral to gain access to cheaper capital. China stocks have soared roughly 35% since then, drawing significant interest back into the region.
With the US election roughly a month away, stocks typically exhibit higher levels of volatility during the last few weeks before voters head to the polls. Although stock returns have historically been a bit below average during election years, 2024 has been exceptional. The S&P 500 is having its best election year through the end of September since 1936. With the outcome of this election still very much in the balance, a new report from the Leuthold group noted that stock market performance during the last three months before Election Day has been a strong predictor of presidential elections. They noted that going back to 1928, when the Dow Jones is up during the final three months of the election, the incumbent party has won 20 out of 22 times. The Wall Street Journal observed that the Dow Jones is up 5.5% since Leuthold’s 11-week key window started on August 13. Stock performance these last few weeks, though, could affect sentiment as final Election Day nears.
In its Summary of Economic Projections, the Federal Reserve is forecasting two more rate cuts this year and four in 2025, with a median long-term policy rate around 2.75%. Of course, we have seen the precarious nature of trying to predict the future level of interest rates. Given the complexity of the global economy, history tells us that reality may look vastly different. The US managed to solve deflation and then inflation seemingly unscathed. The cycle is not yet complete though; history will eventually judge how we finish.
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