The New Rate Guidance
A rate cut is now likely in September
With the eyes of the nation on a tumultuous and atypical presidential race (or, perhaps for the apolitical among us, the Paris Olympics), a series of data points has developed over the past month that provides a clear indication of an economy that is at an inflection point. Whether the turn leads over a cliff or merely to a plateau remains to be seen. But the potential turmoil is there, and the table is set, finally, for some meaningful interest rate cuts as soon as this September. What does the data show and why is this the time for cuts? Let’s dig in.
Consumer Spending
On July 26th, the Personal Consumption Expenditures (PCE) report for the month of June was released, which showed a modest but clear trend downward in spending. For better or worse, we are a consumer driven economy, and the deceleration in spending is evidence of a slowing economy, which is certain to have ripple effects into other areas:
Hiring
On August 2nd, the jobs report for the month of July showed a definite slowing in hiring. Employers created 114,000 new jobs for the month, which was 35% below what economists were predicting. Unemployment rose to 4.3%, which was the fourth straight month of increases. Year-over-year wage growth was 3.6%, which was the lowest annual increase in over three years. However, on a more positive note, weekly jobless claims actually edged downward in a report released one week later on August 9th, which provided some counterbalance to the poor data from the week before. But the robust hiring and extremely tight labor market we saw from 2020 through the early part of this year is definitely looking a bit different now. The risk for the economy is that hiring continues to slow and more people start to lose their jobs. This can have a fast and robust ripple effect; when people are out of work, they don’t spend, and when people don’t spend, businesses struggle and more people are laid off, which perpetuates this downward cycle.
Japan
While conversations here in the United States continue to shift towards the topic of rate cuts, across the Pacific Ocean things are different. On July 31st, the Bank of Japan raised interest rates to their highest level since 2008. Why? The economy continues to run hot in Japan, and nominal wage growth is pacing at its most robust level since 1997. Because the global economy is a pretty tight and tangled web, the impact of the Japanese rate hikes were felt around the world. The Nikkei Stock Market (in Japan) dropped by 12.4% on Monday, August 5th. U.S. stock markets dropped by 3% on the same day, but did regain much of the losses throughout the rest of a volatile week. Still, fears of economic weakness in Asia have cast doubts on the sturdiness of other national economies, including here in the United States.
More on Stocks
While the stock market is not necessarily an indication of the overall health of the economy, people do feel the results of a down market in their investment accounts including 401(k)’s and other retirement accounts. There is a so-called wealth effect when the stock market is doing well, and the opposite is true when the market is volatile to the downside; people feel notably less well-off. Furthermore, there is a lot of evidence in the field of psychology that people feel the negative effects of loss much more intensely than the positive effects of gain, so when the stock market is down as much as it was at the start of this past week, it can generate pretty negative collective feelings about not only the stock market but the economy in general. This also has risks of a doom spiral; if people are feeling less well-off due to stock market losses, they may pull back on other purchases, and, as noted above, this has ripple effects throughout the economy.
What Does it All Means
The two questions on everyone’s mind are 1) how to invest right now and 2) when are interest rates coming down. On the first question, all usual disclaimers should apply about how I am not an investment advisors and you should consult with one when making financial decisions. The point I would like to make, however, is that it is very difficult to time the market perfectly. People who pull money in and out of the stock market attempting to do so almost always lose. It would have been understandable, for example, if someone had sold all their stocks Monday morning when the Dow Jones opened up down 1,000 points at around 38,700. By the end of the day on Friday, however, the Dow had rebounded to nearly 39,500, a recovery of about 2.0% over the course of the week from the Monday lows. If you are approaching retirement or already in retirement and cannot afford to lose much in your investment/retirement accounts (or if market volatility is keeping you awake at night and/or affecting your physical health), you should invest moderately with a nicely balanced mix of investments and only adjust to rebalance but not necessarily to react. This standard, vanilla advice is still the best course of action for most people.
It is also good to remember that stock market drops of 10% from peak to trough happen at least once every 12-24 months on average. What we saw over the course of several days in early August may not have felt pleasant especially if you look at your statements on a daily basis, but it also was not super out of the ordinary even if the drop did happen pretty rapidly.
As to the second question about interest rates, the likelihood now seems high that rates will drop in September by a quarter point. Some economists have even suggested the Fed will drop rates by a half point, although I think this is unlikely as doing so might send a message that the economy is weaker than it truly is and could lead to somewhat of a panic; half point cuts are usually reserved for emergencies. It would not surprise me, however, to see a quarter point cut in September and another quarter point cut in December.
Interest rate cuts would be good news for a lot of borrowers, especially those with variable rates. But rates are only coming down if the economy is showing risks of faltering. So these potential rate cuts should be taken with a grain of salt: the potential benefits of declining rates are likely to be counterbalanced by weakness in the economy, which would include slower spending, less hiring with potential job losses, and stock market volatility: in short, all of the things we have seen over the past two weeks. Even soft landings (and hopefully we will achieve one in lieu of the firmer type) can feel bumpy.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.
No weekly round-up this week as I had a particularly busy week at work and I spent my Saturday at an all-day track meet with our kids. This was the last summer track meet of the year (state championships for youth summer track here in Maine), and the kids did awesome. Have a great week, everybody!
