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Investment Strategy
by Larry Adam
Chief Investment Officer, Private Client Group

These signs suggest the Fed need to get going on rate cuts

September 6, 2024

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

• Labor market conditions are easing
• Soft start to September for the equity market
• Noticeably weaker low-income consumer

The start of football season – my favorite time of year! Week one started with a bang, with a matchup between my hometown team, the Baltimore Ravens, and the Kansas City Chiefs on September 5. While it was a hard-fought win for Kansas City, the reigning champs are on a quest for a three-peat – which is unprecedented in the League’s 104-year history! And just like football teams are bound to make adjustments throughout the season to improve their performance and adapt to new challenges, Fed officials must recalibrate their policy stance to ensure the economy stays on solid footing to achieve that elusive soft landing they have been aiming for after their quest to squash inflation. Here are five signs of weakness that emerged this week that suggests the Fed needs to get going in cutting interest rates:

• Labor markets easing | The once red-hot job market has cooled considerably. So much so that Powell mentioned the Fed “does not seek any further weakening” in the labor market during his Jackson Hole speech a few weeks ago. Since then, there have been a flurry of soft labor reports – starting with a sharp drop in job vacancies (lowest reading since Jan 2021), a weak ISM manufacturing report (with mentions that companies are reducing headcounts and initiating hiring freezes) and a Beige Book that painted a more downbeat outlook for the economy (with 7 out of the 12 Fed districts reporting flat to softer hiring conditions). In addition, the non-farm payroll report this morning showed that the economy only gained 142k new jobs, a tad softer than expected, with the unemployment rate modestly declining to 4.2%. With more data suggesting easing labor conditions, Powell knows that “the time has come to adjust policy” – and we expect the Fed to deliver a 25 bps rate cut on 9/18.
• Yield curve shifts ‘un-inverts’ | Market expectations for Fed rate cuts ramped up over the summer as softer economic data (particularly jobs related data) and cooling inflation suggest that it is time for the Fed to start dialing back some of its policy restraint. This has led to a sharp decline in yields across the curve, pushing the 2-year Treasury yield below the 10-year Treasury yield for the first time since July 2022 – ending the longest inversion streak (at least temporarily) on record at 790 days! This is noteworthy as historically, when the yield curve uninverts (i.e., moves from negatively sloped to positively sloped) it has signaled that a recession is near. Despite the yield curve’s strong track record, our forecast is that we avert a recession. Why? The Fed has plenty of firepower at its disposal to cut rates to support the economy through this soft patch to keep the expansion going.
• Equities soft start to September | The equity market has struggled post-Labor Day. This is not unusual, as September is historically the weakest month, on average, dating back to 1950 – particularly in open election years. In addition to the seasonal headwinds, this weakness could remain in the near term as stretched valuations (S&P 500 P/E trading in the 93rd percentile), investor optimism (% of bullish investors above 50%), and the potential downside in 2025 earnings forecasts (particularly in light of slowing economic activity) leave the market vulnerable to a modest pullback. Despite this, we remain optimistic longer term, as a Fed-induced soft landing and positive earnings growth provide a favorable backdrop for equities over the next 12-24 months.
• Interest rate-sensitive sectors struggling | While it has been just over one year (July 2023) since the Fed’s final rate hike, the lagged impact from past Fed tightening is dampening economic activity – most notably in the interest-rate sensitive and capital- intensive areas. For example, motor vehicle sales (one of our favorite economic indicators as consumers would not make a ‘big-ticket’ expense without feeling comfortable about their prospects) declined to the second lowest level over the last 18 months as elevated interest rates impacted affordability. Construction spending (which is cyclical and capital intensive) posted its first monthly decline in over 20 months. And finally, manufacturing is struggling, with ISM Manufacturing remaining in contraction territory for 21 out of the last 22 months. Notably, some of the more forward-looking sub-sectors, production and new orders, fell to their lowest levels since May 2020 and May 2023 respectively – suggesting that manufacturing activity is likely to remain weak.
• Noticeably weaker low-income consumer | 2Q24 earnings results suggested a bifurcated consumer with the low-income cohort challenged by the cumulative impact of inflation and a deterioration in savings. Consistent with weakness at other discount retailers, such as Five Below and Dollar General, Dollar Tree reported results this week that lowered estimates, citing consumer weakness in the second half of the year. Notably, Dollar General said the recent trend of slowing spending toward the end of each month suggested that the consumer was running out of money each month. Given a slowing labor market and a savings rate at the lowest level since mid-2022, consumer spending is likely to moderate further in the second half of the year.

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