Fed Pivot, Inflation, and the Risk of Recession | Episode 164 | 08-26-2024

Is the Fed about to pull off the impossible—a perfect soft landing for the economy? Join Megan Horneman on this episode of "Markets with Megan," where we discuss the recent Fed pivot that has everyone talking.

After the Jackson Hole Symposium, Chairman Jerome Powell hinted at potential rate cuts in the upcoming September meeting. We address three important questions: Is inflation truly under control? How aggressive will the Fed's next moves be? And has the Fed successfully navigated us toward economic stability without a recession?

We'll explore the balance the Fed must strike between curbing stubborn service-side inflation and responding to a weakening labor market. With the next labor market report set to be a game-changer, will the Fed opt for a cautious 50 basis point cut? Equity markets are optimistic, but economic data casts doubt.

Key takeaways:
** Fed’s upcoming rate cut expectations and the September meeting.
** The current state of inflation and the labor market.
** Economic indicators and the possibility of a recession.

Stay tuned for more insights on how these developments could impact your investments and the broader market. Don’t forget to like, subscribe, and hit the notification bell to stay updated with the latest episodes. For more in-depth discussions, visit marketswithmegan.fm

Well, on Friday last week, we finally got that Fed pivot that everyone's been waiting for. This is Megan Horneman and this is Markets with Megan. We're back this week because we wanted to address the Jackson Hole Symposium where the Federal Reserve Chairman, jerome Powell, basically baked in the rate cuts for the next meeting in September. That meeting is held September 17th and 18th. What does that mean? First of all, there's three main questions. Now that we have this pivot and the next move is likely rate cuts, there's been three questions that come to mind. First of all, is inflation officially behind us? Second of all, how aggressive can or even does the Fed need to be? And then, lastly, is it now OK to say that the Fed has orchestrated this perfect soft landing? Now, what the Fed did on Friday is remember they have a dual mandate. It's maximum employment and price stability. They've been focusing on that price stability, which is inflation, for the past two years, and they came out on Friday saying that the risks have now turned and shifted more towards the weakening in the labor market. So they believe that this policy shift is necessary. Now, from the inflation standpoint, yes, they've done a lot of hard work aggressive rate hikes, a fixing of the supply chain. This has all contributed to inflation at the headline consumer price index level, going from about 9% all the way down now to 2.9. We've also seen a big deceleration in the core level as well. We're not quite at the Fed's 2% target, but they have told us that they wouldn't wait until we got there, until they would cut rates. Now what we're keeping an eye on, though, from the inflation standpoint, is that the sticky side of inflation and we've talked about this often this is primarily in the service side. This is primarily in the service side. This is still growing at very uncomfortable levels for the Fed, and there is always that risk of reigniting inflation if they get too dovish. They've made it clear they don't want to stop and go monetary policy, so they are walking a fine line there when it comes to the inflation standpoint. Now, how aggressive can they be? There's a lot of expectations that they'll cut 50 basis points at the inflation standpoint. Now, how aggressive can they be? There's a lot of expectations that they'll cut 50 basis points at the September meeting. This completely hinges on the labor market report that we'll get next week. If that labor market report comes in okay or better than expected, those 50 basis points will be priced right out of the market. So we think that they do have the flexibility because we've seen basically a 0.6% increase in the unemployment rate over the past six months, typically leading up to a Fed rate cut all the way back to 1966. We looked at all the Fed rate- cutting cycles. You tend to see inflation only up about 0.1% before they start cutting rates. So it's not out of the realm of possibilities that they can come in and adjust policy in September. However, the unemployment rate still does remain pretty low in historical standards. So they have to be very careful there on how aggressive that they cut rates. We are not in the camp that they can be that aggressive.

The last question that is out there is have they orchestrated a soft landing? The equity markets would tell you they have. They would tell you, with basically most of the equity markets sitting at a record high, is they have orchestrated this perfect soft landing? That is extraordinarily rare. We're not there quite yet, not so fast.

And when you look at all of the economic data, economic data is falling pretty quickly. We saw it as well today with the preliminary reading on durable goods. This doesn't necessarily mean that we're in for a soft landing. Can it be a harsher, harsh landing instead of this hard landing recession? It's still early to tell, but there was many different things that we see that are recession leading indicators, that are warning, flashing warning signs, and they've been doing this now, for some of these more than a year. So we're not quite there to say that we are going to be able to skirt a recession. We are seeing this economic data continue to weaken.

So what does that all mean?

Where is our camp? What do we think with this? The Fed's going to likely come in in September. They'll cut interest rates. We're not ready to say 100 basis points for the rest of this year is in. We're also not ready to say over 200 basis points over the next year is completely doable for the Fed because the inflation is still not exactly where they want it to be. Basically, the unemployment market, the labor market, still remains good, not great. It's getting weaker, but we haven't seen a big spike in the unemployment rate that you tend to see in recession, so we don't know how aggressive that they can be. Also, when you look at the money supply, we've seen money supply actually increasing here in recent months, so that's an inflation indicator. That's something the Fed has to be careful of. So they're walking a very fine line. We think that we'll probably get one basis at 25 in September, maybe another in the November meeting and then in December. But I think that there's also the chance that they'll be in this kind of wait and see mode. They're going to keep the markets on their toes as far as every meeting they can make an adjustment to policy.

The problem that we see is with the equity markets. They're pricing in this very aggressive tightening cycle and also this perfect landing in the economy. That's what concerned us, with elevated inflation, with high expectations, with all of this already priced in where we are right now, there's a lot of room for disappointment. So the markets will be closing, falling very closely to that employment report next week. We'll be back. This week there's lots more economic data we'll be out with and we'll be back to discuss how that's impacting markets. And again, if you like this, please subscribe. You know, like hit that alarm bell. And if you want a bigger library of our podcast of Markets with Megan, feel free to go to marketswithmeganfm. Thank you.