There is more to the September US Fed rate cut than meets the eye!

By Subho Moulik

Let us, for a moment, survey the lay of the land before the eventual September 17-18 rate cut liftoff.

What do we have?

A Federal Reserve Chief has emphatically stated that the “time has come” for rate cuts.

Two inflation gauges, namely, the CPI and the PCE, indicate that the Federal Reserve has successfully stamped out inflation.

And markets that have pockets of positive sentiment in expectation of a material rate cut in mid-September.

With all these three elements in place, one could expect that the markets are on their way to reclaim new heights. 

Well, almost.

The catch — and a big one —- is that the Fed, in its zeal to tamp down inflation, may have swung the pendulum too far with a longer duration high-interest regime than required or ideal. In doing so, the market suspects it has flipped the economy into recessionary territory, consequently pushing the US economy into a new period of uncertainty.

What gives?

Well, for starters, the July jobs report (released in August) sparked recessionary fears and sent big institutional market players scurrying for cover. 

The unemployment rate rose to 4.3%, the highest in the last three years. While this may be low by historical standards, the three-month average unemployment rate has sailed past the 12-month low by more than half a percentage point. This is the Sahm rule in operation, and, in the US, it is held in high regard as a likely indicator of a recession.

Even if we are to put the Sahm rule aside, there are other developments to contend with. 

For instance, in late August, the US government released updated employment figures for the 12 months through March 2024.  As per the report, the US economy created 818,000 fewer jobs than initially reported. Simply put, the initial employment creation estimate of 2.9 million jobs was inflated by 30%.

This is the biggest revision of jobs data since 2009. The revision also begs a fundamental question: How do we know, for a fact, that the July jobs report does not have pumped-up numbers that would be revised downwards later on?

The straight and simple answer is that we don’t. And this, in a nutshell, is what the market fears. Some market participants believe that the US economy is currently fast approaching a recession, and current economic indicators are falling short of capturing this underlying evolving state of economic affairs. 

Historical evidence indicates that since 1928, in the last 16 of the 22 cycles, all rate-cut cycles have commenced when the economy is already in a recession or the economy subsequently slips into a recession within 12 months of the first rate cut of a new rate-cut cycle. 

It also doesn’t help that on September 3, the US market suffered another middling meltdown, with the Dow Jones plunging by 626 points and the Nasdaq shedding 3.3%.

The trigger was the release of the ISM’s purchasing manager index which came in lower for August compared to baked-in expectations. S&P Global PMI also contracted, whereas US construction spending figures betrayed a higher-than-anticipated decline. All these parameters, seen holistically, signal that any merry-making about a soft landing might be a tad premature. 

Those with rosier viewpoints would argue that the US economy is not in a recession, based on a holistic set of employment and output figures that do not either show consistent secular declines or indicate projected declines. They would be countered by those with more pessimistic viewpoints, who would argue that US unemployment levels are far higher than what the current data suggests and shine a spotlight on the record levels of US debt that make US government intervention with economic stimulus a difficult task. 

As this debate continues, and the markets continue to operate with flawed data, there is a murmur gaining ground that the Fed is already far behind the curve, and it should press ahead with at least a 50-bps rate cut if it wants to play a positive role in facilitating a soft landing and stave off a recession. Better to act decisively than drip feed – the market would say – no matter what one’s current viewpoint on the economy may be!! 

Finally, recession or not, there are new pockets of deep value opening up away from the over-concentrated segment of big tech companies. Pharmaceuticals, investment banks, QSRs, retail trade, and aerospace-defense are all witnessing a new inflow of funds as institutional investors, and some retail investors diversify away from the usual suspects and rotate their funds into promising performers. Hold on to your long-term value bets and see what new value buying opportunities open up in the next two weeks to bolster your portfolio!!! 

(Author is the CEO, Appreciate)

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