The US economy, capital markets and inflation all surprised to the upside in 2024. At the beginning of 2024 economists were estimating Gross Domestic Product “GDP” of 0.0 -1.0%; the estimate is now 1.8-2.0%. Inflation proved to be “stickier” than previously expected but is now on its way to the FED’s 2.0% target. The Personal Consumption Expenditure Index “PCE”, which is the FED’s preferred Index to measure inflation, is currently 2.5%, down from its 7.1% in June 2022. As inflation took hold in 2021 and the first half of 2022, the FED increased swiftly interest rates to ‘restrict’ demand to bring inflation under control. The FED increased the Fed Funds Rate from 0.09% to the current 5.25-5.50% range, to put the brakes on demand and thereby inflation. This restrictive monetary policy is working, evidenced by a weakening labor market and manufacturing activity
Markets now expect the FED will reduce the Fed Funds Rate by 0.25% in September 2024 with a 100% probability; and by the end of the year an additional 0.75%. The bond market is currently “pricing-in” a Fed Funds Rate of 3.09% in June 2025. (See the chart to the right).
The debate is now over as to when the FED will reduce interest rates after FED Chairman Powell spoke in August at the Annual Jackson Hole Symposium. To quote Chairman Powell… “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks……We do not seek or welcome further cooling in labor market conditions.” I conclude the FED will commence a series of rate reductions to shift monetary policy from “restrictive” to “neutral” during the coming months. When borrowing costs (Fed Funds) are substantially greater than inflation they have the effect of restricting investment. And as interest rates approach the inflation rate monetary policy has a neutral effect on the economy.
With the debate now over regarding when the FED will commence reducing interest rates, how do equity markets respond? Charles Schwab & Co. Inc. ”Schwab” recently completed research on this issue reviewing the 14 times the FED reduced interest rates since 1929. While 14 observations do not constitute a “statistically significant” data set, these historical events give us optimism the US stock markets may perform well during the next 12 months. The graph to the right is extracted from the Schwab report.
A little trivia……Why did the Federal Government establish “Labor Day”? The first Labor Day celebration is traced back to 1882 in New York City when the Central Labor Union issued an order to members to take the day off. By 1894 twenty-three states enacted laws to establish the first Monday in September as Labor Day. However, it was the political aftermath of the 1894 Pullman Strike which induced President Cleveland to sign legislation establishing Labor Day as a federal holiday. In May 1894 the Pullman Palace Car Company workers went on strike for better wages and working conditions. President Cleveland issued an injunction and sent federal troops to settle the strike because federal business was affected. Violence and bloodshed followed. Then in June 1894 President Cleveland swiftly signed legislation to codify Labor Day to appease labor and cool down labor strife in the country.
2024 Outlook
Positive Tailwinds
- Economic activity is slowing down moderately causing inflation to retreat.
- We expect the Federal Reserve will commence reducing interest rates in September 2024 and to continue reducing rates well into 2025.
- Earnings of companies in the S&P 500 Index are expected to grow 8-12% in 2024 and 2025.
Negative Headwinds
- Economic growth slows more than expected, and a recession unfolds in 2025.
- Federal deficit spending continues to put upward pressure on prices by adding to “demand” in the economy.
- Inflation measures do not continue along their downward trajectory.
Rich Lawrence, CFA September 4, 2024
DISCLOSURE:
Opinions about the future are not predictions, guarantees or forecasts. Investing in stock and bond markets have risks that could lead to investors losing money.