The Fed is Not Cutting in September

At the risk of becoming the least popular guy in class, I am going to take a contrarian view and boldly proclaim that the Fed is not going to cut rates in September. I make that statement with a lot of conviction.

Going back to my Fed prediction for 2024, I leaned towards a two to three rate cut scenario rather than the six cut base case being so aggressively bandied about. That has not changed for me, writing this on July 22. At the time, my stated assumptions were that "the consumer remains broadly healthy, nominal growth moderates, geopolitical events are benign, and the election season passes uneventfully."

While the consumer has remained broadly healthy (despite early signs of fatigue) and nominal growth has generally moderated, geopolitical events have skewed more extreme and the election season…well let's just leave that alone for now. While my original thesis of two cuts still holds, I see November and December cuts of 25 bps each rather than a 50 bps or larger reduction.

So why won't the Fed cut in September? There are three ideas to unpack: The persistent Fed culture of data dependency, the Fed's ability to impact lending rates without changing the Fed Funds Rate, and the desire of the Fed to avoid continued politicization in a unique election cycle all support a low and slow approach to rate cuts.

Reason 1: Data dependency supports a rate cut, but it does not demand one

Data dependency can be a dangerous thing. Even if we put AI to the side, it's possible to get lost in the miasma of all the monthly releases or to exhibit a confirmation bias by cherry picking data points that support one's narrative. Examples of both can be seen summarizing the data from earlier in July.

While the big headline was the surprise CPI print, PPI and Consumer Sentiment readouts support multiple interpretations. The CPI print supports the "path to 2%" narrative regardless of whether you subscribe to the Headline, Core, Super Core, or Mega Core measure (ok, Mega Core is not real…yet). While PPI was a bit hot, the trend remains in line there, too. Do we need to get to 2%, or are we close enough? What about R*? What about inflationary fiscal or foreign policy? All fantastic questions for an engaging conversation-at another time.

The slight drop in Consumer Sentiment, increasing delinquencies in auto loans and credit cards, and agita over housing would tend to indicate cracks in the workhorse consumer, but taken in context with non-farm payroll and wage data year to date, my takeaway is that while the situation could deteriorate, the consumer remains in a favorable position.

Net net, the data seems to support a September cut. And yet here we are. How does Fedspeak impact my rationale?

Reason 2: Fedspeak can impact financial conditions aka The December Pivot

While I continue to shake my head in disbelief that it is already mid-July, let us travel back in time to December 2023. Recall Chairman Powell's press conference when the market's interpretation was a victory lap over inflation and an acknowledgement that the Fed was willing to cut rates even if the economy didn't slip into a recession.

The 10-year Treasury dropped 43 bps over the following two weeks from 4.20% to 3.77%. July MTD has seen the 10-year plummet 24 bps from 4.48% to 4.24%. The week after July 4 is typically one of the slowest of the year. I'll be curious to see where the 10-year moves over the rest of the month as market participants digest Chairman Powell's statement and adjust their positioning accordingly. But given that type of price action, the market effectively implements a rate cut across key lending rates with a wink and a smile, leaving the Fed Funds Rate unchanged.

Keep in mind that the Fed will see July and August CPI prints, jobs numbers, etc., before the September meeting. With the market ready to pop either direction based on single data points, do we effectively create a synthetic cut based on Fedspeak and market sentiment?

I think that has clearly been observed over multiple time periods. Chairman Powell has continued in the tradition of past chairs Yellen and Bernanke in open communication style, but in my opinion, the broader market tends to be too focused on the single data point and not the broader messaging from the FOMC.

Noting that the September meeting falls six weeks before the election, with the next meeting occurring the week of the election. Could/should politicization be taken into consideration?

Reason 3: Avoiding politicization ahead of the election

While the Fed positions itself as politically independent in pursuit of its dual mandate of price stability and full employment, each side of the aisle tends to tweak the narrative as seen fit. Given the potential combustibility of both sides combined with a hotly contested general election, a mere six weeks between policy meetings, and data that can be presented to support either a cut or the status quo depending on perspective, in my opinion it is simply easier for the Fed to wait until the November meeting to cut. We've been here before.

Wrapping up

There are several implications of Fed cuts being shallower or occurring later than expected. While I expect to see two cuts over the remainder of the year, a November initiation would indicate that this week's equity rotation and interest rate volatility were both early (if not overbought). But that also implies that yields can drift higher should a September cut not occur, meaning that investors of all stripes have time to add duration and underwrite quality. Mortgage rates should benefit from this week's price action, but that may prove to be short lived should the first cut extend to November.

With rate cuts achingly close, I think it is also important to remember that while rates are at generational highs, they remain close to the average over the past 40 years and tend to correspond with the "Great Moderation" of Greenspan more than the punishment of Volcker. In my opinion, rates are not overly restrictive at these levels. However, they are disconcerting because of the distortion caused by ZIRP and QE over the past 17 years.

Cuts are still coming, just not until November. Keep calm and carry on!

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