Charlie C. from Baltimore, MD asks: Hello Mitch, I saw last week that inflation has come down further just before the Federal Reserve is set to meet this week. Do you think the move was enough to push the Federal Reserve into a 50-basis point rate cut? How do you think stocks would react to a bigger cut? Thank you.
Mitch’s Response:
Thanks for writing. August was indeed a good month for inflation data. According to the U.S. Labor Department, the consumer price index (CPI) measure of inflation rose 0.2% from July and 2.5% from a year earlier, which marked a solid improvement from July’s 2.9% year-over-year increase. Core CPI, which strips out volatile food and energy categories, rose 3.2% year-over-year, roughly consistent with July’s print.1
You can see in the chart below that the CPI (blue line) and Core CPI (red line) continue to trend in the right direction, which has very much opened the door for rate cuts.
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By the time readers see this Mitch’s Mailbox, the Fed may have already made their decision on rates. Whether it ends up being 25-basis points or 50-basis points is not of great consequence, in my view. At this stage, what I think is more important is the overall direction of rates, not necessarily the magnitude of each Fed decision.
As far as stocks are concerned, regular readers of my columns know that I do not see monetary policy as a critically influential factor determining the direction of markets. Stocks have gone up during periods of rising rates (see 2023 as a prime example), and they’ve also performed well during periods of easy monetary policy. There are too many other factors—namely earnings—influencing stock prices for one Fed decision to make or break the markets.
It follows that many investors assume that falling interest rates are automatically bullish for stocks. That tends to be true throughout a policy cycle, but history also suggests that stocks can be volatile early on when rate cuts commence. The reason is that historically, the Fed is too late in lowering rates, and they usually have to cut deeper and for longer than most people expect at the front end of their policy pivot. The Fed may be closer to ‘on time’ in this policy cycle, but that remains to be seen. We remain bullish for other key reasons: expected earnings growth in the next year, lower inflation in the future than we have today and lower rates in the future than we have today.
As the Fed keeps a close eye on inflation, investors must be prepared for any outcome.
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Disclosure
2 Fred Economic Data. September 11, 2024. https://fred.stlouisfed.org/series/CPIAUCSL#
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