Did the Fed Wait Too Long?
Investors continued to take gains and head for the exits this week as signs of an economic slowdown grow. For much of the year, the consensus was for a “soft” landing meaning inflation would return to a more historically normal 2% while the economy continues to grow by 2%. It was the goldilocks scenario where the Fed, through its grit and determination, brought inflation under control without crashing the economy (perhaps for the first time in history). Unfortunately, much like the Fed held interest rates too low for too long causing the overheating of the economy and laying the groundwork for the tremendous spike in inflation that followed, it now looks like the Fed has held interest rates too high for too long and risks causing the next recession. The pullback we’ve witnessed over the past few weeks speaks to the quickly shifting market sentiment and the growing fear that the Fed is now behind. As has been expected, this pullback is overdue and likely an unpleasant speedbump until we get past the November election.
While nerves have been fraying for a little while now, it was the jobs report that sent investors into panic mode today. The July Nonfarm payrolls report showed that only 114K jobs were created last month, down sharply from an average of 200K-300K over the past five years. Accompanying this slowdown was the unemployment rate which grew to 4.3% and triggered what is called the Sahm Rule which is defined as the three-month unemployment rate rising by half a percentage point from its low over the last year. The good news is that this almost certainly means the Fed will cut rates at its September meeting (if not before, although this would be unusual and perhaps spark fear). And expectations are growing for a 0.50% rate cut instead of a more modest 0.25% cut. Additionally, the probability of a second rate cut in November or December is also rising. The tricky part is that the Fed must signal rate cuts are coming without causing undue distress among investors who will undoubtedly fear the world is ending. I’m being dramatic, but if I’ve learned one thing over the past three decades in this industry, is that the market doesn’t always react rationally.
As for the other elephant in the room, our national debt continues to grow unabated, surpassing $35 trillion this week. At the current rate, we’re putting on approximately $1 trillion in new debt every three months. In more normal times, we might expect to hear our presidential candidates put forward plans to combat this growing problem, but these aren’t normal times. Depending on who wins in November and whether Congress remains split, or one party takes control, we should expect more threats of a shutdown and budget partisanship to cause further uncertainty in the financial markets. The expiration of the current debt limit suspension is on January 1. For now, this is not in the spotlight as the mainstream media chooses to focus instead on the insults the candidates fling at each other daily. The silver lining is this spiraling debt will put pressure on the Fed to cut interest rates, if for no other reason than the rapidly increasing interest expense on the national debt. Not to put too fine a point on this issue, the U.S. national debt is now larger than the economies of China, Germany, Japan, India, and the United Kingdom combined. Let that sink in.
On a slightly different note, if you have been in the market for a home or perhaps pay rent to a landlord you may have noticed rents and home prices haven’t come down despite inflation having almost returned to normal. In fact, I mentioned the phenomenon of million-dollar starter homes in many cities across the country just last week. Between the shortfall in the supply of homes and mortgage rates that are significantly higher than we’ve become accustomed to, you may feel both stuck and pinched. Well, you’re not alone. I read this week that Starbucks has closed its iconic Greenwich Village store as New York City rents soar. The store had been known as Astor Place and had been at that location for almost thirty years. The manager is quoted as saying, “The landlords jacked up the rent so astronomically high that even Starbucks couldn’t pay it.” It almost makes me feel sorry for Starbucks. The Astor Place location was one of the first Starbucks in NYC and opened in 1995. Now you know (you’re not alone).
Bruce J. Mason, MBA