“The Time Has Come …”
“… for policy to adjust.”
That was the key sentence in a speech Federal Reserve Chair Jerome Powell gave a few weeks ago at the central bank’s annual gathering in Jackson Hole, WY. And with that, the Federal Reserve is set to begin lowering its benchmark interest rate in a few days at its next policy meeting. With annual inflation continuing to move toward the Fed’s goal of 2%, it has appropriately turned its attention to the other half of its dual mandate: employment, where trends are clearly weakening.
The question now isn’t whether the Fed will cut, or when. It’s by how much—a traditional quarter-point cut or a more-aggressive half-point cut? As we write this, financial markets are assigning close to even odds for both (although we note that these probabilities can and do shift quickly and markedly). Just as important as the answer here will be commentary around expectations for how long, how quick, and how deep this rate-cutting cycle might be.
As a practice, Clayton Wealth Partners does not make explicit forecasts for recession. However, we do spend a lot of time thinking about current conditions and probabilities about what those conditions might lead to. By our work, the risk of recession in the not-too-distant future remains high. To be clear, we’re very much open to the possibility of the soft-landing scenario, but a significant amount of the employment data we monitor is trending in the wrong direction, consistent with prior recessions. We need to see those trends turn around in short order.
One of the arguments we hear from those squarely in the soft-landing camp is that interest-rate cuts will be enough to stave off a recession in the near term. Rate cuts will surely help the economy, all else equal, but critically, it typically takes time for changes in rates—in either direction—to impact the broad economy.
By themselves, interest-rate cuts are not enough to eliminate the threat of recession. The exhibit illustrates how recent recessions (indicated by the shaded areas) began only months after the Fed embarked on previous cutting cycles.
Exhibit: Recessions and Fed Funds Rate
Source: Federal Reserve, BCA Research, Clayton Wealth Partners.
Only time will resolve the debate around a hard landing vs. a soft landing. We will remain diligent with our analysis as events continue to develop.
Bullish
- The Fed has made good progress in reducing inflation since 2022.
- The Fed appears poised to start cutting interest rates in 2024.
- The most attractive yields for fixed income and cash in years.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Slowing global economic growth with recession pressures mounting.
- Banks are tightening lending standards.
- Housing affordability remains at a decades-low.
- Leading indicators of unemployment are generally trending down.
- Delinquency rates on consumer loans are rising.
- Russia-Ukraine war, Israel-Hamas conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.