by Peter Jones, CFA
Senior Vice President
Research and Portfolio Management
For sports enthusiasts and market participants alike, this week was all about the number 50. For fans of America’s favorite pastime, Dodgers star Shohei Ohtani became the first player in the history of professional baseball to record 50 home runs and 50 stolen bases in a single season. Ohtani achieved this historic accomplishment with a bang, going 6 for 6 with three home runs and 10 RBIs … in a single game.
For investors, the number 50 marked a shift in monetary policy as the Federal Reserve cut interest rates by 50 basis points (0.50%) on Wednesday. Going into the week, there was a debate among investors, strategists and economists about whether the Fed would cut by 25 or 50 basis points. Markets applauded the more aggressive easing in policy, with stocks rallying another 1-2% and the S&P 500 reaching yet another all-time high. For our firm, the debate around 25 or 50 basis points is largely academic. Not only is the difference negligible, but it also takes 12-24 months for Fed policy to have an impact on the real economy. Those hoping that the Fed cuts will quickly result in an economic acceleration are likely to be disappointed.
Although it takes a while for Fed policy changes to transmit through the economy, there are pockets that have already seen relief, most notably, the housing market and mortgage rates. The average rate on a 30-year mortgage peaked at 7.80% about a year ago. Since then, the market has gradually priced in lower inflation, resulting in lower Fed policy rates as well as lower long-term interest rates. Today, the average 30-year mortgage rate is 6.0%. While housing affordability remains challenged, the significant drop in rates is a relief for first-time homebuyers and for those looking to move.
Perhaps the biggest immediate beneficiary of an easing in Fed policy is the federal government, where spending and associated interest costs have become unhinged. As a frame of reference, federal interest payments in 2024 will exceed the entire national defense budget for the first time in history. More than 50% of federal debt comes due in the next three years, and the average rate on federal debt is well below short-, medium- and long-term interest rates (chart below). While Congress may look to a lower interest rate burden as a green light to continue spending, this modest expense relief is a distinction without a difference. After all, we’re talking about a $2 trillion budget deficit, around 6% of GDP.
Source: Strategas
To summarize, the Fed is gradually shifting its policy stance from a restrictive position to a more neutral level. Our expectation is that the Fed will be measured in its approach so long as there is no recession (chart below). By the end of next year, the Fed Funds rate should be around 3%, a level thought to be neither restrictive nor stimulative to the economy. For the market, we expect earnings, not policy changes, to determine whether the upward trajectory we’ve enjoyed since the beginning of 2023 is set to continue.
Source: U.S. Federal Reserve
Takeaways for the Week
The Fed officially marked a change in its policy direction by cutting rates by 0.50% on Wednesday
Changes to Fed policy take a while to transmit through the economy. As such, the change is more about signal than immediate impact
The direction of the market will depend on earnings, not Fed policy, from here