How Rate Cuts Could Push Markets to Historic Extremes

Last week I predicted that Powell would soon shift course by focusing on job growth rather than inflation.  That shift would allow him to announce that the time had come to lower interest rates while glossing over the fact that inflation is still a full 50% above the Fed’s 2% inflation target.  True to form, Powell spoke to us on Friday from Jackson Hole at the Fed’s annual economic conference and noted, “The time has come for policy to adjust. We will do everything we can to support a strong labor market as we make further progress toward price stability…My confidence has grown that inflation is on a sustainable path back to 2%.”   Powell has been hell-bent on lowering interest rates, and he is going to start the next easing cycle in September.

Under Powell, the Fed had lifted its benchmark rate to the highest level in over two decades in order to get control of the nation’s worst inflation in more than forty years.  He claimed that due to the Fed’s efforts inflation has come down steadily, and that, “There is good reason to think that the economy will get back to 2% inflation while maintaining a strong labor market,’'  Powell sounded confident that the Fed would achieve a so-called soft landing — containing inflation without causing a recession.  Yes, it felt totally disingenuous for him to take a victory lap considering how badly the Fed had bungled the management of the inflation almost three years ago, but Powell is a brilliant tactician, and investors love his persistent message that supports the stock market.

In fact, the decline in inflation has been anything but steady, as the Fed had been promising rate cuts since last year. The initial rate cut has been delayed for many months due to a sharp rise in inflation in the first quarter of this year.  In any event, a rate cut in September is nearly certain, and the market is actually pricing in cumulative rate cuts of 100 basis points over the Fed’s next three meetings this year.  As Powell, said, “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data…” 

Let’s examine what this all means and where things are heading.