Time to Cut Rates

Stocks closed mostly in the green today, and the bond market rallied in reaction to a slew of not-so-great economic data. The Dow fell 24 points, while the S&P 500 climbed .5% and the Nasdaq rose .9%. On the bond side, iShares’ Core Aggregate Bond ETF (AGG) rallied .5%. Long-term Treasuries were up over 1%.

In a way, bad news is good news. Somewhat weaker economic trends may cause the Federal Reserve to begin cutting interest rates immediately. Certainly, bond traders are beginning to bet on lower rates going forward. The Fed-funds futures market implies a 70% chance of the first rate cut occurring by September. There is a sense that the Fed has gotten away with restrictive monetary policy for a long time now, and it is beginning to bite.

I’ll quickly recap what Fed officials are seeing right now. The government revised first quarter GDP (that is, economic growth) down to +1.3% from its prior estimate of +1.4%. The downgrade is admittedly small, but the main driver was lower consumer spending (1.5% vs. 2.0%). And investors are hyper-sensitive to any data suggesting consumers are more financially cautious. Also, ISM’s closely-watched business activity surveys (both manufacturing & services) fell sharply in June and suggest weaker hiring activity. Next, while certainly not critical, the volume of unemployment insurance claims is beginning to tick up. At the same time, several different measures of inflation are once again in decline. The Fed’s preferred measure—Core PCE—is down around 2.6%, the lowest rate since March 2021.

All of this should give a green light to rate cuts. And right on cue, Fed Chair Powell sounded more “dovish” in a CNBC interview yesterday. He acknowledged inflation is moving in the right direction, and that risk of economic damage will continue to increase if they leave interest rates at restrictive levels. In particular, he said any significant softening of the labor market would cause the Fed to cut rates.