• Second cut of the easing cycle, dropping the Fed Funds range 25bp.
• New Fed Funds range is 4.5% to 4.75%.
• Unemployment has “moved up but remains low.” 
• Removed dovish language that “inflation is moving toward … 2%.”
• Acknowledges that inflation “remains somewhat elevated.”    

On course

This afternoon, the Federal Reserve Open Market Committee lowered the range for its Federal Funds rate by a quarter of one percent. The new range is now between 4.5% and 4.75%. The Committee’s statement led with the usual “data dependent” sentence about “recent indicators suggest that economic activity has continued to expand at a solid pace.” More on that in a moment. The FOMC appears to be on course to slowly lower rates over the next year and a half.

A key change in the statement is that the Committee removed the phrase “gained greater confidence that inflation is moving sustainably toward 2 percent.” The remaining reference to inflation states that it “has made progress toward the Committee’s 2 percent goal.” We interpret the removal of the first sentence and removal of the word “further” in front of progress as less dovish. In other words, since inflation has stopped moving lower, perhaps a pause in rate cuts would be in order. Skipping December would be a possible outcome. The recent rise in Treasury bond yields appears to be driven by both fears of higher inflation in coming years and more deficit spending by Congress.

Skipping ahead

Another puzzle in the statement is the risk phrase, “roughly in balance.” If the good and bad risks for the labor market and inflation data are in balance, then is there a need to do something? The Fed Funds futures market may agree, as the odds for another quarter point cut at the December 18 meeting have fallen over the last week from well above 100% to near 70% today.

How about a pause in rate cuts? Chairman Powell was fairly candid in his response, stating that “it was something they were just beginning to think about.” In other words, a rate pause would be on the table if inflation rose in next two CPI reports. The October reading will be released on November 13 and the November report on December 11. There will be only one more job report on December 6. Recent jobless claims and private surveys such as the ISM Services Employment index suggest hiring is holding steady. We think manufacturing employers have been sitting on their hands for a number of reasons, mainly waiting on the elections. If headline CPI heads above 3% and unemployment drops below 4%, we would expect the Fed to begin skipping rate cuts every other meeting.

Join the crowd.

Over 70% of all central banks have cut rates this year. This week, 20 central banks are making interest rate decisions. These central banks represent over a third of the world’s economic output. Recent data shows pockets of weakness, specifically Germany and parts of Europe. Brazil, India, Canada and the U.K. all have positive momentum. The U.S. continues to lead the pack, growing around 2.5% this year and at least 2% in 2025. We expect rate cuts to continue around the globe as countries attempt to shake off shutdown stupor. New orders for both services and manufacturing are turning up in a number of countries. New orders support future earnings, in turn supporting the ongoing Bull market in stocks.

“Solid”

Now about that first line in the statement. It is true that economic activity is growing at a solid pace. We would suggest a solid “second gear” pace. Not too hot, not too cold.-Four years removed from government-imposed shutdowns, our economy is chugging along between 2% and 2.5% real growth. Comments from our clients and business survey suggest some are waiting to see what tariffs and regulatory changes are coming next year.

One policy that is solidly in place is the Fed’s buying of Treasury bonds. They continue to buy bonds, averaging $150 million per month, per the latest Treasury activity release. As the mortgage securities on the Fed’s balance sheet mature, some of the proceeds are reinvested in Treasury securities. The Fed’s regular buying supports the market, keeping interest rates lower than they would be without their buying.

Analysis

We remain a bit wary of the Fed’s goals in cutting interest rates. With over $35 trillion in Federal debt, the Fed has an interest (pun) in keeping interest rates below the rate of inflation. With inflation at 3% and Fed Funds at 4.5%, they have a way to go. With rates below inflation, in the long term, paying back that debt slowly gets easier. In the short term, lower rates help keep interest expense down.

Fully $15 trillion of our federal debt matures by the end of 2026. Its average interest rate is 2.6%.-Two-year Treasury notes today are trading at 4.2%. Refinancing that $15 trillion today would raise its interest costs by roughly 60%, or about $240 billion. More borrowing is not the answer.

Summary

The economy did slow in the summer but appears to be in better shape heading toward the new year. A recession is not our playbook over the next six months. Markets are taking the rate cut in stride, content to have cheaper borrowing costs and the prospects of lower regulation.

Please let us know how we can help you.

Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. 

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