Power Lunch - Stocks are flat as Fed delivers super-sized rate cut 9/18/24

Episode Date: September 18, 2024

Stocks are little changed after the Fed lowered interest rates by a half-percent, making investors optimistic about a “soft landing” for the economy. The FOMC lowered its overnight lending rate to a range of 4.75%-5% from 5.25%-5.5%. We’ll break down what that 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.

Breaking news it is. Welcome to Power Lunch, ladies and gentlemen. Alongside Kelly Evans, I'm Tyler Matheson. From Washington today, we're just minutes until the Fed's decision, Kelly, on interest rates. The markets are clearly in wait and see mode, literally almost unchanged for the S&P, the Dow and the NASDAQ as well. Will it be 25 or 50, and maybe more importantly, how will Chair Powell explain and set expectations for what the Fed plans to do next, especially as it relates to how many more cuts are in the pipeline, Tyler? I'm very curious about this, as we've talked a lot there about,

two full points of cuts in the pipeline over the medium-term horizon. If that's not their plan and the bond market needs to meet their kind of higher mentality, that's fine. If it is the plan, then it could signal, as we've been discussing, a weaker economy than we previously thought. Let's get right to our All-Star panel, as we are just minutes away now, about three minutes from the Fed decision. Joining us is our friend David Kelly, JPMorgan Asset Management, Claudia Somm, of New Century Advisors back in this hour, and Jim Karen of Morgan Stanley Investment management. Let me let you, Claudia, tee up the conversation here. You believe that the Fed should cut rates by a half point. You say the SOM rule is forecasting a recession, but SOM herself

doesn't see that. Go ahead. That's correct. I think the Fed needs to begin the normalization process. The interest rates, as Greg Ips said, these are high. They need to start moving them down. A 50 basis point cut is not a crisis response. It's a start that process. and do it with some recognition that the labor market has cooled off relative to where we were even back in July. So that's the reason to start moving maybe a little bit more. But really, it will be extremely important to get the game plan from J. Powell today as to where they're thinking over the next couple years. Because this is going to be an ongoing conversation about what's the next rec cut, how big is it, when is it? And we need some guidance.

So we're not always in this like guessing game right down to the water. for a quarter point instead of a half point? Well, I think the economy is fine, and I think the issue here is the messaging. I think it's very important that Jay Powell say, look, inflation's come down, it's coming down, but the economy itself is strong, so we can afford to be gradual here,

bring it down 25 basis points. I think we might see three cuts this year still, so I think they can bring it down every meeting by 25 basis points, but don't shock anybody by bringing it down 50. Don't give the sense that there's something wrong with the economy, because frankly, economy is growing just fine. Jim, do you agree with that? And how do they square an economy growing just fine with the concern about inflation? We've heard both candidates mention and what they're

hearing from constituents. How do they message that? Well, look, I think one of the things that they're going to have to message is that there is risk to going 50 basis points. And one of the risks is that they could unanchor inflation. We saw PPI, we saw CPI data come out. The inflation data is it's coming down but you know there is some sign that it might be slowing we still think it's coming down we don't think inflation's a big problem look the fed has to take a bet here they are taking risk the risk is if if they don't take a big bite right now and go 50 basis points that it could be that the unemployment rate accelerates higher and that creates a bigger problem down the road but the other side of the risk is that if they do go too fast and inflation then starts to perk up a

little bit too high, then I think they've been, they've basically signaled to the market that they're very aggressive and that this could create a bigger problem down the road. So in my view, I think 25 basis points on a risk-adjusted basis is more warranted. But that doesn't mean that a very good place could be made for 50. All right, Jim, thanks very much. We'll come back to you in a very short time. But we are just seconds now away from the Fed's decision on Interstates. And for that, Let's go to Steve Leasman. 50 basis points the Federal Reserve cutting interest rates by 50 basis points to a new range of 4 and 3 quarters to 5%. There was one dissent Fed Governor Michelle Bowman, preferring to cut by 25, but 11 voting in favor of 50.

It might have been close. I'll come back to that at the end of this report. The statement says the committee will consider additional adjustments to policy based on the data, the outlook, and the balance of risk. The summary of economic projections saying additional. 50 is expected or forecast by the median Fed member for this year, for a total of 100 this year, that would bring the median down a 4.4% or an additional 50 basis points from where we are right now. Another 100 basis points of cuts expected through next year bringing the rate down of 3.4%. All of that, a bit above where the market is priced.

And the new long run rate would hit 2.9%. That's up a tick by the year 2026. The statement now says the Fed is firmly committed to supporting both maximum employment and the 2% inflation target before and for many months before this, the Fed had relied solely on saying it was focused on the inflation target. The committee has gained greater confidence. The statement said that inflation is moving to that 2% target and risk to both sides of the mandate now are said to be roughly in balance. On the economic description, the economies continue to expand, it says, at a solid pace. job gains, however, have slowed. Inflation making further progress towards 2%, but remains elevated. It seemed declining to 2.3% this year, to 1 next year, and hitting the target 2% by 2026.

Unemployment, the outlook for Enholt me did tick up. I think that's important to what the Fed said here and what it did. Up 0.4 to 4.4%, two ticks higher than it is right now. Growth pegged at 2%, slightly above the 1-8 potential, well into 2020. Now, nine officials in the dot plot wanted to do 75 basis points or less this year, and 10 wanted to do 100 or more. So it may have been a very close call as to what was actually wanted around the table in terms of 25 or 50 today, but they decided ultimately with 11 voting in favor of the 50 basis point, Raycut. Tyler. All right, Steve, stick around as we get back to our panel for some reaction.

Claudia, you were the one who said 50 basis point cut, and that's what happened here. Clearly, maybe more emphasis on what's going on in the labor market than on inflation. This is absolutely a vote for the dual mandate, and so trying to protect maximum employment. You know, things are good right now. They're not pointed in a good direction with the labor market, but that's why you get out ahead of it. So this is a risk management, and it's showing that the Fed is taking the risk on the labor market. very seriously, and that also shows up in the projections. They are trying to move.

This is not the last cut. So it's a really important recognition of what we've been learning about the labor market and the Fed is reacting to it. So David Kelly, they're opening big, and you think that another, well, you said that by the end of the year we would be three quarters of a point lower than we are today. That would imply then that there would be at least there would be two more cuts of 25 basis points or at least one. Yeah, no, I think we probably will get two at this stage.

I mean, I would have preferred they went 25 basis points today. Obviously, it's a very close call in futures markets. But the important thing to recognize is a cutting interest rates at the start doesn't stimulate the economy at all. There is a J-curve effect. It actually slows the economy because people begin to anticipate those lower rates or they want to wait for lower rates. It tells people that the Fed is scared about unemployment.

I don't think they really should be, but that's the message it gives. So it undermines confidence. The reason I thought, you know, bringing it rates down from a high level is like, you know, bringing a piano down as a flight hysteria is you've got to do it very carefully and very slowly. That would be the right way to do it. And I'm a little worried that they started off in a rush here. But I do think this economy is strong enough to deal with it. I think we will, you know, next year I think we'll get 2% growth, inflation, 2% unemployment, close to 4%. So I think it's still a healthy, strong economy.

Does it risk it in any way, Jim, reigniting inflation? Look, I mean, you know, to some degree, it mean, it certainly could, but it really depends on what happens to the labor markets. Look, I see this as a three-dimensional problem for the Fed. Number one, where do they see the neutral policy rate being? Number two, how quickly do they want to get there? And number three, what is the employment situation? Is the employment situation going to deteriorate more quickly? What the Fed is signaling today is that they are very concerned that the unemployment rate could start to accelerate higher.

So to me, yes, you know, this could be something that might unanchor inflation. I think it's way premature to say that. I don't think that's what's going to happen. But what it does signal, it does signal that they are worried that there could be a faster pace of layoffs and job losses and things like that. So I think the markets, while they may be happy that the Fed cut interest rates, they might have to ask the question is why they're going as fast as they're going and what is the cause for that concern.

So I think it is a little bit of a double-edged sword here. Claudia, what about that very interesting point that David made, and that is that perversely, sometimes cutting interest rates can slow down activity as people wait for interest rates to go even lower. Right. Well, the first thing I'd say is we know from this cycle already that the comparisons back to history are going to be really tricky. We haven't had a kind of easing cycle like what the Fed has started us into in a very long time. And we've had a lot of what are fed interest rates even doing in this cycle. So I think there is that issue. Now, markets, and this will be a very important part of the press conference today,

is this messaging from Powell about going forward with interest rates. You can get that quote unquote forward guidance and have the market rates look out ahead. And this is a Fed that with a 50 basis point said, we are going to do this. And we are going to be, and that's really aggressive, but we're really going to move on it. And I think that can show up in market rates and then help with that, you know, behavior changing. David, one aspect where I'm very curious about how markets and banks react is Americans have actually been making a lot of money on high rates if they have their money in money market funds, if they hold treasuries and so forth. You know, taking things down a half point doesn't change a lot, but it might just be enough. And I'm curious what your take is to kind of start moving money around.

And at the margin, take a few dollars out of what's been a very lucrative place to part cash. Well, I don't think it'll have that effect. I mean, I do think that it's squeezing the income of older Americans just a bit. But what it does, I think it will introduce the question of, well, how much is the economy slowing? And that is not necessarily good for the equity market, no matter how much it, you know, a positive response to what they've just done today. I mean, as I say, I think the economy is strong enough to handle this. But overall, you know, I think the messaging is very important from here. So in the press conference, it's very important that Jay Powell stress the level of comfort with inflation.

Look, we've got lower gasoline prices down 70 cents year over year. We feel good about growth, but honestly, inflation is doing even better than we thought it was, so that's why we can move today. If he stresses progress in inflation rather than worries about unemployment, then he'll do the economy a great service, and I think that'll make this a much safer cut. Steve, Claudia made the point. I invite you to pick up on whatever thought or tangent you would like, but Claudia made the point that this is a different circumstance.

We haven't had this kind of initiation of a rate-cutting cycle in a long-time, certainly not under these kinds of circumstances. When we've had rate-cutting cycles before, it's been in response to economic crises, like the pandemic, like the financial crisis in 2007, 2008, 2009. Here it's a different set of circumstances. Economy's pretty good. Very little sort of idea that recession is on the horizon.

Talk to me through that. Talk me through that, if you wouldn't mind. Well, Claudia studied history. That's why she's famous in our world. world. I've studied history maybe a little bit less, and I can tell you with experience that nothing works, Tyler, in terms of comparing this to any of the cycles. There have had a complete lack of analogs for the world we're in right now. Fundamentally, it seems like what the Fed decided is this was really a transitory supply shock, somewhat exacerbated by somewhat loose

monetary policy, somewhat loose deficit spending. But if you hear the Fed talk now, much of blame ends up being on the supply side shock that kind of worked itself out. A lot of that created a background of why the heck are we so high if it was a supply shock and it's largely worked itself out. We have another half a point, maybe a full point to go depending upon how you want to measure it. And we can get that done by being restrictive, but we don't have to be this restrictive. What Powell took, I would say, Tyler, is 50 basis points of what could be an easy 100, 150 that the Fed can take and do so while remaining restrictive and not even be in danger of sort of further stimulating the economy. The game now is going to be restraining the market and its forward pricing of where the Fed is going. because that forward pricing, Tyler, as you know, works itself into the real economy through the

floating rate mechanism that allows businesses to go out and borrow at tomorrow's yield. And that's where the stimulus comes from. So now we begin a game of the Fed on top of the horse holding the reins and figuring out how much to let out the reins and how much to pull back. Right now they let it out 50. It's a great point, Steve, to emphasize that's where a lot of this will hit the real economy. And in some ways, that moves already been made and we'll see how markets react. And on that point, Jim Caron, I just wanted to point out, you know, if you told me that they were going to cut 50 and asked me what I thought the stock market reaction would be, I could go either way.

The reaction so far has been positive, though, and that seems to be a sign that they're taking the kind of this will be stimulative on the margin and keep the soft landing intact story, as opposed to the, we're at the beginning, like Tyler was saying, of a recession. and as we've seen with past cuts of the size. Yeah, I think the market signaling that this is a step in the right direction for the soft landing. I want to pick up on one thing that Steve Leesman said, because I think the eye on the prize here, what we need to be focusing on is where the terminal rate is. Where they begin this journey to cutting interest rates is an interesting point to talk about today. But what the markets are going to focus on ultimately is where do they end? So the faster they start cutting today, that means they might go slower later on. In other words, they get this move done with,

and we get this stimulus that the economy needs from rate cuts, and yes, that's a, you know, that's positive for markets. Markets will view that as a very positive thing. But remember, what markets are we talking about here? So ultimately, if the Fed goes 50 basis points, goes very aggressive, you know, cuts 100, 150 basis points, does that mean that their terminal rate? Do they end at 4%? Do they end at 3.5%? Because right now, the bond markets have been pricing for the Fed to cut 200, 250 basis points, if that doesn't happen, that represents a disappointment to that asset class and that could lead to a selloff, maybe in 2025. Also, if the Fed doesn't cut this full amount that's being priced in today, does that represent a disappointment even to the equity markets

at some point in time? Because equities are counting on this 250 basis point rate cut as well. So what's ultimately going to matter in this thing is going to be the data. It's going to be the employment situation and ultimately we're going to see how inflation creeps into this as well. So look, we're at a good starting point right now. The Fed has done something very aggressive. This is friendly to risky assets. There's no question about that. But ultimately, the question we need to ask ourselves is where does this end? And that's good. That termination value is going to determine the value of asset prices in the medium term. Yeah, no, and we have to go. But I just wanted to kind of go back to that dollar chart, which is showing soft,

And again, you know, on the margin, you're talking about possibly re-igniting certain commodity prices and import inflation. Steve, last word. Kelly, Jay, just give you a quick pricing here. We're at a 62% probability of another 25 in November, but a 93% probability of a 50 in December, which seems to be roughly in line. Maybe it's a quarter heavy, given what your last guest was saying. Market and the Fed now don't seem crazily at odds over the outlook, maybe a little bit more aggressive. next year, but right now they're within 25 basis points. They'll resolve that. But right now,

25 built in for November, 50 built in for December. And the Dow has now gone negative. So it's spiked to record highs and has now given those up as it maybe it's changed its mind now, as believing more in the hard landing story. Well, thanks to our panel. We appreciate to joining us today, David Kelly, Claudia Somm and Jim Caron. Let's get to Mike Santoli. Now he's over at the New York Stock Exchange. Mike, what do you make of this stock market reaction? Well, in some sense, Kelly, it is the typical, you know, first twitch is maybe the wrong move, and then there's going to be a backlash, and then there's going to be a rethink of the backlash all in the next couple of hours. So that's not unusual. I do think the instinct to suggest that there was more

relief than not in the 50 basis point decision makes some sense. 25 basis points, while it would have been fine, given unemployment where it is, and given the recent run of data, has been pretty reassuring. I still think it would have made the market just that much more sensitive to any softness and data over the next seven weeks until the next Fed meeting and maybe left the impression the Fed was willing to fall behind, even if it's not behind just yet. All that mixed together, I think, has to be put against the fact that the S&P 500 was already near a record high, already at 21 times forward earnings, already pretty much juiced up on soft landing expectations. I don't mean that it's overdone, but it's absolutely

based on the premise that we probably are going to keep an expansionary economy and rates are going to be tilting lower at some angle. So all that mixed together, I get the response, longer term yields up a little more, so therefore a little more steepening of the yield curve. Really not an aggressive response in what you would consider to be the playbook for the Fed cut, meaning small caps and regional banks and things like that. They kind of rallied into it a little bit more on a week-to-date basis. So maybe we'll see if that's to come as we get through the day. All right, Mike, thanks very much. Let's now go to Shikon. and Rick Santelli for the reaction in the bond market.

Hey, Rick. Hi, and indeed, I'm going to have to start out with the dollar index, Tyler. I'm sorry. Dollar index has some significant technical issues it's going to deal with. Now, you're all talking about it, and granted the low is around 100.39. But the key here is any kind of a close under 100.5 is going to be a technical violation where we're almost guaranteed to test if we can hold up at 100. And it certainly looks like it's a possibility.

50 basis point cut, of course, is igniting issues with relationships to the dollar index, not only with the end, but with the euro. Now, if we switch gears and we go to the two-year, the two-year was at 353. 353 before the announcement. It's at 357 right now. It's been as low as retesting. That was pretty much the low right around 353. And if we look at tens, they were around 359.

They're higher, of course. they're at 365. Now, forgetting the numbers a bit, as you look at interest rates, a couple of things should jump out at you. Right now, about half the curve is above where it was yesterday on the close, meaning seven-year, 10-year, 20, or 30-year-year-olds are higher, but it's starting to creep down the curve. The equities have given up some of the ground,

and the interest rate complex, first initial reaction was a rally pushing yields down. Then they bounce back. Now they're coming back down. to be a big two-way trade probably till Q&A, but what you really want to pay attention to is the yield curve. Right now it's steeped about five basis points, meaning long-term treasury rates are a little more stubborn in terms of coming to the game and rallying, pushing yields down. And ultimately, if you listen to our panel, pretty much every guest we had on today, you know the good side of what the Fed did. But the other side you're going to hear a whole lot

more about in the next 15 hours, A, 50 basis point cut this close to an election, B, 4.2%. There used to be a time when that was considered full employment. And when you look at some of the averages on job growth, they're still on most metrics above 100,000. So with equities making new highs, this is a unique Fed situation. And some Fed watchers are going to be scratching their head. Back to you. The yield curve has de-inverted. Am I correct? Yes, yes. Right now you're at 9.6. Your lower yields on the twos, your higher yields on the tens.

All right. Rick Santelli, thanks very much. Appreciate it. And markets are reacting across the board to the Fed's kind of surprise decision. Look, going into 2 p.m. It was almost a 50-50 call. We had really receded the possibility that this could happen. The Fed delivered 50.

There was only one descent. Stocks initially went to record highs. Then the Dow pulled back by 400 points, in fact, within minutes. and now it's climbing again. We'll get more on the market reaction as we build up to the chair's press conference at 2.30 Eastern Time. We'll take you there, of course,

as soon as it begins, and Power Lunch will be right back. Welcome back. We've seen Wipsawed markets after the Fed's decision at 2 p.m. to cut interest rates by half a point. The Dow had been up to session highs, all-time highs, in fact,

briefly turned negative is up 188. S&Ps up half a percent. NASDAQ, the highest up eight-tenths or so. For more on what investors need to know, Mark Avalon is here. He's President Epiton. wealth advisors. What are you advising? Mark, welcome. Well, welcome. And that was a big surprise for me. And I think investors shouldn't go out and make any knee-jerk responses. But I think there's

going to be some opportunity here. We've talked about the relative valuation differential between small, mid, and the large-cap mega-cap. I think a lower-rate environment is going to serve small and mid-cap well. So that allocation, still not too late to get there. Again, it's literally about 50% on a forward PE of what the large cap mega cap is. So we find that attractive. We also think investors, whether this is a slowdown 50 basis point cut or a preempted, we want to get out in front 50 basis point cut, we think technology is the way to go. I know I've been a broken record, but technology, tech enabled, old tech, new tech, the only tech we don't want is non-cash-flowing spec tech. That is not what we want. Otherwise, we are all in on technology.

Let's talk a little bit about interest rate sensitive sectors, and I'm thinking mid-sized banks, most especially, large banks. What happens there? Well, this may be a contra opinion. I actually was a Bank of America down the street for a number of years, and my take on banks is a void. I think what's going to happen is the repricing of loans. Now that the Fed has cut is going to hurt their top-line revenue number,

and that cost of good sold. Yeah, the net interest income is going to come down because it can charge less. But if you think deposit rates are dropping 50 basis points today, we'd have to have a debate. The deposit rate is going to be sticky. It's not 30 years ago when the banks controlled all of the deposits, and they would lower rates on the deposit side and keep loans higher. The reverse happens now. There's so much competition for consumer deposits, money markets.

So you think they were sticky when they were low. Banks didn't want to raise deposit rates. Now you think they're going to be sticky at a higher level. Yes. We're going to see the impact of no. non-banks, brokerage firms, you know, these specialty lenders. I was out looking in the green room at current money market rates. There's some places that are offering over 5% still.

So they're not going to be dropping 50 basis points when that loan revenue drives for traditional lenders. Now, this is the opportunity is to go to a diversified financial, one that has capital markets, trading, asset management. But a traditional community bank lender, I have a little hesitation on. Quickly on bonds, any thoughts there, fixed income? might be a little late. You know, everyone's been set making the call, and we've been riding that lengthening duration. I'm going to pause on that right now.

It's more of a flat yield curve. I'd like to see if this is a 50 basis point because of recession. I think we just hold steady duration neutral right now. All right, Mark, thank you very much. Mark Avalon. Appreciate it. Good to be here.

Thank you. And we are just moments away now from Jerome Powell's press conference, and we will get more reaction to that. And the Fed's decision to cut by a full half point when Power Lutz returns. All right, welcome back to Power Lounge. We're just moments away now from Fed Chair Powell's press conference.

And before we do that, let's bring back Claudia Somm, New Century Advisors, Chief Economist. Claudia, it would seem as the chair has some adroit needle threading to do here. What do you expect him to say? I expect Jay Powell to give a very clear message on the decision they made today to really explain what it is and the criteria that they're going to use as they go forward. forward. How strong suit is his communication and an ability to just say it. And I think that's what they will lay out today in the press conference. And that's what we absolutely need. So he needs to bring that. You know, as you say that, I think back to his hawkish press conferences that used to upset the market, you know, they would come out with something to the reaction to be relatively ho-hum. And then he'd start to talk and we kind of get this big sell-off. Is it now, so I thought going into today it might be the opposite, where maybe they go 25, but then he's quite dovish as he has been.

kind of going back to Jackson Hole and talks about the labor market. Now that they've gone 50, I don't know if I should expect Dovish Powell or more moderated Powell to explain, no, no, the economy's not that bad. And so I'm just trying to think through this. You know, it is clear because of where the decision landed that the Federal Open Market Committee had a lot to talk about in the last few days, last few weeks. And so he's going to come out and communicate the plan. And so I don't want to hazard a guess as to exactly what that is.

Now, you know, the action is pretty dovish today, so going more dovish might, you know, push the markets even further. And I think if you look at the summary projections, you don't have Fed officials on their own going much, much more dovish than where, say, the markets are right now. I think a lot of it is just explaining where we're at and where we're headed. And largely, there seems to be some agreement between the Fed and the market. So they don't, you know, he doesn't need to do anything too fancy here. Can we go all the way back to our conversation in the last hour with Elizabeth Warren?

I'd like to ask an economist, how much of the inflation that has taken place over the past three to four years is related to price gouging? Literal price gouging. The pandemic kicked off a lot of disruptions, supply chains, also in the labor force, labor shortages. We are going to look back, and I think the research more and more points to the COVID disruptions. are the key source. Now, COVID created a lot of circumstances, right? It did shift some of the pricing power. It did. There were opportunities, and also with the war in Ukraine. So it gets into this very tricky, what's the cause, what's the problem.