Fed’s Rate-Cutting Cycle Begins
In a widely anticipated announcement, the Fed cut interest rates by 0.50% at its September FOMC meeting. The Fed had telegraphed a rate cut ahead of time, though the size of the cut was the biggest unknown; in the days ahead of the meeting, the market was divided on the magnitude, assigning a near 50-50 chance of either a 0.25% cut or a 0.50% cut.
In the long term, we believe that monetary policy and interest rates will return to a more “normal” environment. While the Fed has now embarked on a rate-cutting cycle, we anticipate the Fed will ultimately settle on an interest rate level that is higher than the ultra-low interest rates experienced in the post-Global Financial Crisis years through 2021, which were marked by near-zero interest rate policy. The Fed’s forecasts support this view, with a longer-run equilibrium rate of nearly 3%.
In a more “normal” interest rate environment, we expect more “normal” stock market returns aligned with historical averages in the high single digits and more normal levels of volatility. Any uptick in volatility may provide for greater rebalancing opportunities across asset classes.
Mission Wealth’s Overview
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The Fed cut interest rates by 0.50% at its September FOMC meeting and indicated another two 0.25% rate cuts are likely in 2024.
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The Fed and market consensus expect a soft-landing economic outcome, with inflation improving and some labor market rebalancing.
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If the economy avoids a recession, a rate-cutting cycle has historically been positive for stocks, bonds, and direct real estate, though we note stocks have appreciated strongly ahead of today’s rate cut.
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In the long term, we believe that monetary policy and interest rates will return to a more “normal” environment.
Dot Plot Indicates Four Total Cuts in 2024
There was a lot of focus on the Fed’s “dot plot” economic forecasts, as it pertains to the potential future path of monetary policy. The median estimate for the fed funds rate indicates the Fed believes an additional two 0.25% interest rate cuts are appropriate through the balance of 2024 (1.00% of total cuts for the year), followed by another 1.00% of rate cuts in 2025, bringing the target for the fed funds rate to 3.25%-3.50% by the end of 2025.
This interest rate outlook was driven by the Fed’s assessment that inflation would continue to abate over the foreseeable future, while economic growth remains robust, and the labor market experiences some rebalancing. With that said, at his subsequent press conference, Fed Chair Powell made a point to emphasize that Fed policy would continue to be data-dependent moving forward.
In supporting its decision, the Fed’s statement noted that it “has gained greater confidence that inflation is moving sustainably toward 2 percent.” It also indicated economic growth remains robust, while the labor market has experienced some rebalancing, and the unemployment rate has moved higher but remains low. In essence, the Fed is projecting a soft-landing economic outcome. Of note, Governor Bowman dissented from the decision, favoring a 0.25% cut instead.
Soft Landing Expected
Current market consensus is largely in agreement with the Fed’s assessment and outlook for a soft landing. Consensus estimates the economy will expand by 2.5% in 2024 before slowing its pace of growth to 1.8% in 2025 and 2.0% in 2026. The market believes inflation will migrate towards the Fed’s 2% target over time, though it will remain above that level for the foreseeable future.
Divergent Market Outlook
On one hand, the Fed’s and the consensus base case for the economy is a soft landing; on the other hand, ahead of today’s announcement, the market was pricing in rate cuts more aligned with a recessionary outcome. We anticipate the market may be somewhat ahead of itself with the speed and extent of Fed rate cuts; absent a significant deterioration in economic fundamentals, we think the Fed may be hesitant to be overly aggressive in cutting rates and may not veer meaningfully from the path implied in its “dot plot” forecasts, especially if inflation remains sticky and above 2%.
Market Implications
What does this mean for markets? If the economy avoids a recession, a rate-cutting cycle has historically been a net positive for stocks and bonds. However, the current stock market strength leading into today’s rate cut – and the potential for the market to be overly aggressive in pricing in rate cuts – may have “front-loaded” some of those potential returns. Not to mention the potential for an uptick in volatility ahead of November’s election.