Transcript
Amada Agati:
No more asking, "Is it over now?" because just like that, Federal Reserve Chair Jerome Powell put an end to the market's cruel summer of wanting clarity on interest rate cuts with his Jackson Hole speech. But we know all too well that that's not the whole story.
The last two months have been tricky for investors, between the equity rotation out of large caps and the brief but extreme global market sell-off.
In this edition of "#AddingAlpha," we put the prospects of coming rate cuts into context and discuss what it means for markets. Although we're not even three-quarters of the way through this year, once we're back to December, we think 2024 could prove to be a tale of two halves.
During the first half of the year, megacap tech drove equity market performance to new heights as investors awaited the Fed's next move. Then came the July 11 CPI report, which was not only weaker than consensus expectations, but also declined on a month-over-month basis for the first time since May 2020.
This mere hint at weaker inflation set off a proverbial gold rush as investors believe there was finally enough support for the Fed to begin cutting interest rates as early as September. Large cap stocks sold off in favor of smaller and more value-oriented companies that had really been disadvantaged for years amid the high inflation,high interest rate environment.
The market's mid-cap haze lasted just longer than a fortnight, when a weak ISM manufacturing report on August 1st, followed by a softer labor report on August 2nd, introduced doubt into the economic soft-landing scenario, which really, up until then,seemed much more likely than not.
Unexpected policy tightening by the Bank of Japan only added to the market pressure. Investors saw red as a global financial market sell-off ensued.
Up until this point, the market would usually shake it off. Instead, the former narrative of bad news is good news for the economy quickly turned into bad news is bad news, as concern grew that the economy was deteriorating faster than expected and that rate cuts could come as a result of recession. However, the risk-off rally subsided almost as fast as it materialized when investors realized the latest economic data was essentially nothing new.
Credit spreads and equity index levels have since rebounded. The two-year to ten-year Treasury yield inversion has narrowed considerably. And unsurprisingly, futures markets are pricing in significant rate cuts on the horizon. Markets now see 50-50 odds for either a 25- or 50-basis-point cut in September and three more 25-basis-point cuts before year end.
The market wants what the market wants, per usual, craving the sugar high from policy accommodationdespite Chair Powell repeatedly delivering the same message to investors --"You need to calm down."
It's clear from recent data points that labor markets have begun to cool, but some economic softening is not entirely unexpected, given the long and variable lags of Fed policy actions. Weaker labor statistics were a key focus of Chair Powell's commentsat Jackson Hole, during which he voiced his most ardent support of rate cuts yet since the Fed's pause began over a year ago.
With both inflation and labor markets finally normalizing back to pre-pandemic levels, we believe recent trends have eased the way for a 25-basis-point cut in September. Believe it or not, S&P 500 earnings growth expectations are still hovering near 11% for 2024 and 15% for 2025. While interest rate cuts are very welcome at this point in the cycle, financial conditions have already been easing since the Powell pivot last October.
In our view, it suggests the effects of easing policy may be a bit more muted than investors expect for priced to perfection equities. It's not necessarily the end of the Eras Tour, per se, but the beginning of the Fed's easing cycle, and likely makes for a choppy ride into year end.
