Power Lunch - Fed cuts by a quarter point, indicates fewer reductions ahead 12/18/24

Episode Date: December 18, 2024

The Fed lowered its key interest rate by a quarter percentage point, the third consecutive reduction and one that came with a cautionary tone about additional reductions in coming years.We’ll break down what it all means for both markets and your money, right up until Fed Chair Jerome Powell’s press conference. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome everybody to Power Lunch alongside Kelly Evans. I'm Tyler Matheson. Glad you could join us on this Fed Day. We are just about three minutes and a half until away from the Fed's decision on interest rates. Meantime, while we get ready for that, why don't we get a quick check on the markets? As you see, the industrials moving the other way today. It's been a long stretch of negative days for the Dow. Today up 165. The S&P up about a fifth of a percent. The NASDAQ up a quarter percent. and Russell, the 2000, is up about six-tenths of our 1%. Let's get right to our All-Star panel, joining us as often they do. David Kelly of J.B. Morgan Asset Management,

Stephanie Roth of Wolf Research and Jim Karen of Morgan Stanley Investment Management. Let's go around the horn, Jim. Why don't you knock us off? Don't knock us off. Kick us off with your thoughts on what the Fed is likely to do today and likely to say. Well, look, I think it's a mark-to-market exercise. Given where the Fed was, you know, back in September when they released their summary of economic projections, the 10-year note is up 80 basis points, the two-year note is up 70 basis points,

the dollar is 7%, you know, more expensive on the dollar index. I think the Fed needs to adjust to where the markets are. The question, though, for the Fed is how quickly can they do that? They came out with a forecast back in September, and I think they need to adjust that upward, but I think it's going to probably be minor, just given the way that the Fed typically operates, and it may disappoint the market. That the interest rate forecast will be revised upward. Am I hearing it correctly?

Yes, that's correct. So I think that they need to take the dot plot, probably 25 basis points higher, all across the board. All right, Stephanie, your thoughts? Yeah, I think that's fair. The key thing that we're going to be focusing on is the long run dot. That will probably come up by about 25 basis points, but I think the market's anticipating that. This will probably be a meeting that kind of comes and goes without too much excitement. The key things that we're going to be wondering about is,

is Powell going to answer anything about fiscal policy? Probably not. And then how do they change the projections for next year? Certainly not unlikely to be four cuts and the projections probably will look something like three, although in our actual base case, we're calling for something like two. So we don't expect the market to move that much at the margin because the market's looking for something a little more hawkish, potential for a doveish surprise. Stephanie's looking for a little bit of a nothing burger today, David. How about you?

No, some meetings are all about the words and others are about the numbers. And this is about the numbers. And I think there will be significant change. I think they're going to have to upgrade their estimate of economic growth across the board, cut their estimate of the unemployment rate a little bit over the next few years, increase their estimate of inflation a little bit. And I think the result of that is that they're actually going to make some significant changes to the forecast for a rate cut.

So right now, you know, rate cut today, yes. But next year, they're looking for four, 2026, looking for two. That's where we are right now. I think they could reduce that to about three rate cuts at this stage. They might take half those rate cuts off the board. So that is a significant change. And I think they want to indicate, look, we're not going to have that many rate cuts going forward. That is a significant change.

And I remember thinking back a year ago to where many people were saying, we're going to get six rate cuts in 2024. Well, we're going to get half that many. Maybe if you take that and say, we're going to get half that many again, you come down. David, to where you are with a couple next year and maybe a couple in 2026. It is almost that time to get to Steve Leesman. I don't want to hand it to him too quickly because of the strict embargo. But let's go now to Steve Leasman and get the word on rates. The Federal Reserve cutting interest rates by one quarter point to a new level of four and a quarter to four and a half percent.

The committee says in its statement it is still, quote, considering the extent and timing of additional adjustments. Now, the summary of economic projections says it raises the average expected rate to 3.9%. That's an additional half a point than what had previously been forecast, or just two cuts now projected by the committee, by the average committee forecast, down from four quarter point cuts that have been projected. Same for 2026, which now goes to 3.4% expected from 2.9. So that discussion just having, yes, the Federal Reserve did indeed reduce the number of rate cuts it projects for the average committee member next year. The neutral rate is now 3.1 up from 2.9%. One dissent, new Cleveland Fed President Beth Hammack, who took office just a few months ago, she preferred to hold rates. Bottom line, committee is still heading down, but at a slower, perhaps, shallower slope.

Economic activity is said to be expanding at a solid pace, and if you've heard this before, it was really, a carbon copy of the prior statement when it came to the economy. Labor market has generally eased unemployment rate is up. There's been progress on inflation, but it remains elevated. The outlook is uncertain the committee says looking at risks on both sides of the mandate. More on the projections here. Growth was raised by a half a point for this year to 2.5% back to 2.1 and then 2% in the next several years.

Unemployment now seen down 2 tenths from the prior forecast, that is, to 4.2 from 4.3 over the next three years. And one more thing, the more important issue of inflation, where the core PCE is seen up two-tenths to 2.8 percent, 2.5 percent the next year, and then it gets down to trend in 2027. That's the 2 percent number. So quarter point cut, still considering additional cuts, but considering fewer or forecasting fewer cuts than it had been in the past. Tyler? All right. Thank you very much. Steve. Back to you, David Kelly. you kind of nailed it there, David. You said down to two cuts from four next year, and that seems to be exactly what they said. Yeah, this doesn't surprise me at all. And I think what they're trying

to do is lay the groundwork for being able to have, you know, a more cautious approach to monetary easing next year. You know, right now there's sort of this lull between administrations. I think at some stage there's going to be some pressure on them from the administration to be more easy. So I think they'll try to sort of put a stake in the ground saying, this is what you should expect from us so they don't you so they can try and avoid or postpone any fight with the administration next year or in 2026. Stephanie, your reaction? Yeah, I mean, rates have moved a little bit on the back of it, but the market was looking for the Fed to communicate that they're going to slow down their pace of cuts, and they certainly did that. The key thing now is that if you

look on page 12 of the summary of economic projections, that's where you see the risks around inflation, and now it's weighted to the upside, which last meeting it was more neutral. And then similarly on risks in terms of the unemployment rate, it was previously weighted to be a lot higher, and now it's more broadly balanced. So the shift of risks have changed notably, which is why they've slowed down their likely to slow down their pace of cuts in the coming years. Speak to that point, Jim Caron, about the risks on both sides of the mandate, as Steve put it. Yeah, so look, I mean, I think that there is a component of this, which is the unemployment rate, right? So the dual mandate is full employment and stable prices.

So I think what the Fed is effectively trying to do here by continuing to cut interest rates, although it's slowing its pace of cutting interest rates, is it's really trying to do a risk management exercise in the sense that it is probably more worried that you could get an accelerated rise in the unemployment rate if the Fed is too tight for too long. So I think what's behind some of the pace and the directionality of rate cuts right now is that they're trying to hedge that unemployment rate. They need to keep it around that 4.2% level. I think if it starts to rise, it has much more negative effects for the markets later on.

So to me, that's a risk management exercise. That's why they're doing it. Very importantly, though, the market always thinks about these things in terms of sequencing, right? So right now they're cutting by slower. Next thing you know, they're going to pause. And at what point then does the market maybe potentially start to price in rate hikes, even if it's for 2026, that could have more negative impacts for the market. We're not there yet. But the point, though, is that I think it's a risk management exercise for the jobs market.

David, just to go back to this kind of decision, the market's reaction is a little bit more disappointment. Maybe that this was a little bit more hawkish than they expected. And even though people were expecting a hawkish cut, what do you think accounts? Is it the two cuts versus four instead of three? You know, what would you be watching now? Yeah, I think we just have to read between the lines here. The Federal Reserve does not want to get in a fight with the political side of Washington on monetary policy. But if you look at their economic projections, they say, you know, they tell you the Fed ought to take it very carefully, you know, very slowly in cutting rates from here.

And I think their nightmare is that they cut too much. And then, you know, economics tells them they should raise rates. And the administration is saying that they shouldn't raise rates. And, you know, I think they value their independence. They want to be able to do this smoothly. They do not want to have to sort of fight for their independence. And so that's why I think they're very reluctant to cut too much for fear they'd have to raise rates again. Although I'm not sure, David, how many members really want to raise rates, right?

Don't you think institutionally they're biased towards more cutting? I mean, the literature says that, you know, policy is still restrictive, and I think a lot of them are persuaded by that. Well, you know, we live in a world of two R stars. There's an R star for the economy, and yeah, inflation is likely to come down in the long run, because this is not an inflation-prone economy. But if you look at financial markets, there is a lot of bubble and froth in financial markets right now. And you could argue that interest rates are not too high when it comes to financial markets. And I don't think they want to encourage any more speculation in markets right now.

So I think they're trying to avoid that. And that's why they really have to think not just about the economy, but also about financial markets. Jim, let me bounce that idea that David just mentioned off of you. And that is the thought that maybe the Fed is a little worried about cutting too much because then they would fear the political blowback if they got to a point where they had cut what they thought was too much and feel that then they have to start raising rates. And we know that the incoming administration, President-elect Trump, is a fan of lower rates, not of raising rates, of rising rates.

Yeah, so this is a really good nuanced point. I think we need to develop it a little bit. The whole key here is that we don't want inflation expectations to become unanchored. Right now, I think we're in a good place. Inflation's been coming down. Maybe it's moderating. It's not falling maybe as fast as what people would like it to, but we don't want to see it start to rise. If they cut too much and that spurs a hike in inflation, then that's going to spur potentially higher policy rates.

And that's going to have very negative impacts on bond markets, on equity markets, on just financial market valuations altogether. So beyond just the blowback that they may get from Washington, if they have to, get put into a position where they have to hike rates on top of that, they're also going to be looking at a market situation, potentially in equities and in bonds that might also be turning negative two. So there's a lot of things here to unpack and effectively, I think having inflation become unanchored is a risk as well. Steve, can you give us a little more color on the descent? We only had one and it was a different one from last meeting. Yeah, it was kind of interesting to me. I thought there was two possible, maybe three possible dissents. I'm, I

I think the story here is Beth Hammett gave a speech not too long ago where she discussed the idea of one more rate cut between now and when she gave the speech, that is, and January. So I think she clearly had preferred doing it later, I guess getting more data, clearing more. She comes from us from Goldman Sachs, where she was in the Treasury at Goldman Sachs and helped steer that firm through the global financial crisis. So I guess there's a certain amount of conservatism when it comes to financial matters as far as she's concerned. It is interesting, Kelly, to look at the reaction in the Fed Funds' futures markets.

For example, if you look at the December 2025 Fed Funds contract, what you see is the market one-upping the Fed a little bit on hawkishness. Now, this forecast, this average forecast from the Fed, met the market where it was at before it came out. But if you look at what's happening in the 25 contract, they went a little bit more hawkish and now are raising it up towards a 4% for the end of 2025. Also, you have now have a 91% chance of no change at all, 901% chance of no change at all at the January meeting and a little bit lower probability

for Raycuts for both March and May. There's still 50, 60%. So the idea is skip a meeting, maybe skip two meetings and then see where things are. I don't think the Fed fears Trump. And I don't even think it fears reversing course if there's a big fiscal package or a big change in the fiscal policy. I think what the previous speaker just said is what the Fed is more concerned about. Inflation expectations are becoming unanchored. But if they have to raise rates in response to fiscal policy, I think the Fed would do it. Stephanie, your thoughts? Yeah, I mean, I think that's fair, but it's really soon to be starting to talk about raising rates when we're still on a cutting cycle.

And by the way, if the raising rates because of tariff policy, I would argue that's probably some sort of mistake that would lead to a recession earlier on. And realistically, if we get that type of outcome, they would probably just pause and see how things played out, in which case growth will probably slow down. The one thing we haven't talked about today is- So, Stephanie, just for the record, I was just really asserting that I think the Fed is independent of that pressure from the Fed. I don't think it's in route to hiking rates. I don't think that's a discussion that's on the table at the committee right now. I just want to be clear about that. Totally fair and certainly agree with that.

The one thing we haven't talked about is the fact that they've increased the neutral rates that's a 3.1%. Perhaps that's an indication that they're actually just bullish on long-term productivity. That's probably something that's going to come up during the press conference today. And this is a really positive outcome for the U.S. economy, one where you could see higher growth that's not inflationary. And this would suggest slower pace of cuts, but not for bad reasons. All right, David, you get the last word. Yeah, it is nice seeing the neutral rate go up a little bit because honestly, I think it was too low. And I think it's just one more way of the Fed saying, look, if financial market is going to be exuberant,

if fiscal policy in 2026 is going to be very expansionary, we're going to be pretty sober here. We're going to act in the opposite direction. And that's why we're being much more cautious about rate cuts at this point. All right. Thank you to our panel, David, Jim, Stephanie, as well as to Steve Leasman. We appreciate it. Let's get, I guess we're going to go to Bob Bazani right now, right? The market turned a little negative there, Bob.

Yeah, I don't think it's that surprising with them reducing the probability of rate cuts to two. A lot of people in the market had already moved to two to three. But the S&P was up about 10 points as we went into the meeting at the top of 2 o'clock. It's down 25 to 30 points here. So it's taken a little while for this to happen. Actually, it didn't happen immediately. We've been slowly moving towards the lows of the day. This is sort of not typical of the post-cut playbook.

I think Jim mentioned this. Normally, you get a situation where the Fed cuts rates and interest rates move along with them, but interest rates have been trending up recently. And I think that's been a little bit of an issue for the markets trying to figure out what's going on there. We also have inflation that's down, but not going away. One thing that's causing some confusion in the markets is sort of the global economy. Well, the U.S. economy is doing okay. China's not.

European economies are not doing well. Latin American economies are not doing well, and given that a lot of companies, 40% of profits are outside the U.S., that's causing a little confusion in the stock market here. If you look at the S&P this month, it's basically flattish, up slightly, but all the performances of technology and communication services. So essentially it's a month for big cap tech with Broadcom, Tesla, Alphabet, Micron, Amazon, the usual suspects, all up, 5, 6, 7, 8%. Look at some of these moves here that we've had here. These are really remarkable. Microsoft too also doing well. Apple's doing well. But if you look at the broad sector for the markets, most of the S&P sectors are down rather dramatically. I mean, energy and utilities and materials, real estate, interest rate sensitive sectors down. Banks are down about 6%. Health care is down about 6%. So there's a lot of confusion trying to sort this out. Now remember, the first half of December typically is weaker on seasonal pattern. And the second half is where you get to the The second half is where you get the Santa Claus rally in the last five days. So I want to see the next few days how it pulls out here if it does pull out of this little bit of a downtrend that we're had outside of technology.

But right now I think the market's really trying to figure out a little bit more about where the global and the U.S. economy is standing and is coming out quite unsure about what's happening right now. Bob, thank you. Great to see you, Bob. And let's go to Chicago. Get some reaction from the bond market. The interday chart showing a pop-in yields on the decision. Rick Centelli here to explain it. Rick. Yes, big pops and yield.

Maybe the star will be the dollar. We'll get to that momentarily. As you look at intraday of twos, remember, they were at 421 before the announcement came out. They're up about 10 basis points. If you look at tens, they're at 438. Here we are now at 444, almost at 445. basically up eight basis points from where they were. And what's really interesting, if you consider on the 17th of September,

the session right before the 50 basis point first cut, we are now 70 basis points higher in a two, 80 basis points higher in a 10. Now, let's look at the dollar index. This is amazing. The dollar index right now is up almost three quarters of a cent on the session, and most of that was after the announcement. It's going to be looking potentially at a new cycle-high close, and thinking about what all of that means, my impression of what it means is the market's looking at this like maybe this is the last hurrah on easing for a while that would go along with the way you're pairing this move with the equities. And let's just look at the face of this quickly.

The last CPI, we have back-to-back year-over-year core 3.3. The last PPI for November, we saw the core at 3.5%. 227 on jobs last time, not a bad number. GDP, second quarter, 3%. Third quarter, 2.8. Fourth quarter, Atlanta thinks it's going to be over 3%. The market and the date I just described are scratching their head as to the longevity of the rate cut cycle. Back to you. That's a fascinating move in the dollar, and we'll see how much of it sticks, especially through the press conference.

Rick, thanks so much, Rick Santelli. We will hear from the Fed Chair as he takes questions from the press in about 15 minutes time. I'll take you to it as soon as it begins. First, a quick break and more thoughts and analysis right after this. Welcome back to Power Lentch. The Fed just cut interest rates by a quarter point again. It was largely expected, but stocks are falling on that decision amid the projections for next year. Key question for investors is what else Fed Chair Powell will say about that in his press conference.

Bill Lee is here now. He's the chief economist at the Milken Institute. He is also a member of the Power Ledge Mock Fed, and he voted for a cut like this. Bill, welcome, and markets, they're kind of reacting to this by saying, well, wait a minute, just what is inflation going to look like next year for this economy and how many more cuts will there be, really? Well, Kelly, I think the markets are really reacting to the fact that we have a lot of strong tailwinds in the back of us, strong GDP growth, but most importantly, inflation really has not

come down in the places where it's supposed to come down most of all, which is the domestic services area. Even X-Housing, we've seen PCE core inflation rise at about a three and a half percent pace and really hasn't changed since the beginning of the year. And what we have to remember is that the markets, not so much the Fed are in control of that long end. And so when we talk about how are rates doing, are they going upward down? We have to ask which rates? And yes, you're right, all these headwinds strong tailwinds are helping to raise long rates. But the short end is still very tight. We had heard this morning from Brian Mornahan of Bank of America that banks are having an incredibly hard time making loans to small businesses at rates that they can actually use.

Oh, sure. And so we have tightness at the short end and easing of financial conditions on the long end. And so the bond market is really reacting to the fact that the long end, which is what they control, has to get tighter. But the Fed is very convinced that we need to help banks make loans to the businesses that really need them, which are the debt financing business, like small businesses. So we can kind of talk about the neutral rate as it relates to all of this. The Fed said the sort of average or neutral rate has risen to three from 2.9 percent, just to correct our banner, what Steve had said, to 3 percent from 2.9 percent, which might not

sound like a big deal, but you get a three handle. And what does that tell you? It's telling me that the productivity growth that we've seen and the strong head, strong growth that we've seen may actually be sustainable, which means in the long run, the neutral rate has to be higher not just because of inflation, but because of real productivity. And that's a good thing. And that's going to help us have higher wages and lower wages and lower inflation in the future. But right now, I think the key is we're so far above that neutral rate at the short end, the Fed really has to do its adjustments and lower that short

rate down to more reasonable handle, a three handle or three. or better. And so I think what the FOMC discussion is about is, how fast do we do this? How fast do we bring down these short end without frightening the markets in a way that makes them think that, my God, we're going to be boosting inflation even further from where it is? I'm curious, Bill, you and a lot of others similarly situated as you as an economist and a thought leader here, say that we have a strong economy and tailwinds at our back. And yet the Fed seems to be reducing the GDP growth forecast from two and a half percent this year to 2.1 next year to 2.0 in 26. Those feel like fading tailwinds, if you will. Well, it's a composition of that

fade that you need to worry about, and that's what the Fed is worried about. We have the strong tailwinds right now because consumer is very strong, but much of that consumption is based upon 20 percent of the population that owns 40 or 75 percent of stock market wealth. And those people are spending like crazy. They're going on business class of vacations. But the 60, 70 percent of the population that voted for President Trump saying, we can't make ends meet. Those are the people that are having trouble and their consumption is not growing as fast. And what the Fed is recognizing is that we cannot sustain the kind of strong consumption and strong GDP growth that we've seen now and probably into early next year into the future. And that's why their GDP forecast is being

reduced in recognition of the fact that a lot of the consumption that we see, now is going to be coming down. But nevertheless, the strong tailwinds are still there boosting inflation because the rigidities that hold up inflation are still there. So in some ways, the bond market says we need higher rates because inflation isn't coming down. The Fed is saying, right now, we need to anticipate the fact that the growth will start to disappear as soon as consumption starts to cool down. Yeah. Boy, am I with you. I mean, the people who are at the top of the income scale. They are

spending. They are free. We had Ed Bastion of Delta on. They are traveling. Yesterday, we had them on yesterday. People are traveling. But the people who are really being pinched here are the people who are going to the grocery store and finding a 12 pack of bounty for $40. And that hurts.

And that hurts. Bill Lee, thanks. Chief economist at the Milken Institute. Where are we going now? Well, we're just minutes away. The empty podium will not be empty much longer. Jerome Powell's press conference. That's where we're going in a few minutes. We will get more reaction to the Fed's decision to cut interest rates by a quarter point next.

There's one of Chair Powell's assistance, probably putting his binder out there. And he's all ready for him. He'll be there in about five minutes. Welcome back to Power Lunch. Just moments away now. Three to be exact from Fed Chair Powell's press conference. Stocks have already turned lower the Dow off more than 400 points from its high of the morning. now down 186 or thereabouts. So what will happen when Powell starts to speak?

Let's bring in Mike Santoli from the New York Stock Exchange. Your reaction to the statement, to the quarter point cut, and to what looks like a more modest lowering path of interest rates in the years ahead. Yeah, Tyler, I think the market in general was on board with that idea that obviously the Fed was going to be moderating its pace of rate cuts. If you look at where the two-year yield was trading before today, clearly there were not many cuts. seemingly priced into it. I do think that the statement and then also the dissent on this decision to cut maybe crystallizes some of the dissonance out there about this, about this environment that we're looking ahead to next year. Now, the Fed took up its year-end, 2025 estimate of where

inflation will be, yet it still says it's going to cut two more times, and that's the consensus as it comes together. That probably feels a little bit incompatible to a lot of folks here, if we're really at 2.5% PCE inflation, are we really going to get two more cuts? I think all of that just points up that we're at a moment where it's going to be kind of a meeting to meeting and we're going to have to assess all the data. And I don't think it's a problem for the market if investors had rock solid confidence that U.S. growth was really going to be durably strong. I don't think there's a reason to doubt that we're in a pretty decent economy right now,

but the cyclical stocks are not trading as if we have liftoff here in acceleration. They've been trading really poorly for weeks in housing-related stuff. Even manufacturing is really taking a stutter step. Mike, I'm glad you said that because it's exactly where I was going to go with this next question. A lot of people have been focusing on the yield on the tips. We're at 10-year tips. This is at 212 now. And while that might not sound like a big deal, we're up from a low of, you know, in the fall, call it 175.

We're going back towards the highest levels in tips we've seen since 2023. And the point Barry Knapp and others make on this is that when those tips yield start to take off, again, is often when you see the mega caps outperform the equal weights. And it sounds like you're describing that. Exactly. If that's the way the marketplace defense in large part is those mega caps. But also, I think the market's struggling with where this new equilibrium point might be among inflation, growth, and rates. So no doubt Powell's going to say, hey, look, we just write down those projections.

That's not really a forecast. Don't worry too much about that. He will also say the neutral rate. We know it by its works. He says at every meeting. What that means is we'll keep lowering rates. gently feeling for that neutral rate. But now it seems as if they're a little closer

than we thought they were a few months ago.