Split-Screen Fed
Anyone who is tuned in to all things Fed-related may feel that they’re watching things unfold on a split screen.
While Federal Reserve policymakers agreed to cut the benchmark interest rate by another quarter percentage point, the vote was anything but unanimous. Three voters dissented, the most in six years. But what was so unusual was how split the vote was: Two dissenters thought they shouldn’t cut rates at all, while another thought the cut should have been bigger.
Policymakers seem to be watching the current economic movie play out on a split screen. One side shows a cooling labor market, which argues for further rate cuts. The other screen features inflation that has stubbornly remained above the Fed’s target for years and has been reaccelerating, which argues against aggressive rate cuts. Here, the concern is that lowering rates too far and/or too soon could fuel even higher inflation and interest rates later. That’s exactly what happened during the painful inflation episode of the ’70s/early ’80s. The exhibit below overlays inflation trajectories for the two eras.
Exhibit: P/Es of the S&P 500 and Constituents Over Time
Source: Bureau of Labor Statistics, Bloomberg, Apollo Chief Economist, Clayton Wealth Partners.
Finally, we have another Fed drama running parallel with the main feature, and that’s the imminent replacement of current Fed Chair Jerome Powell, whose term ends in May. Time will tell how the economy evolves in the run-up to and during the new Chair’s tenure and how effective the new Fed leader will be in reaching consensus for monetary policy.
Bullish
- The Fed has restarted its rate-lowering campaign, providing relief for consumers and small businesses.
- The most attractive yields for fixed income and cash in years.
- Credit spreads remain contained.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Trade policy uncertainty is having a negative effect on consumer and business confidence.
- Housing affordability remains at a decades-low.
- Job growth has slowed to a standstill.
- Delinquency rates on consumer loans are rising.
- Russia-Ukraine war and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.