We Were No Cuts Before No Cuts Was Cool
This is awkward.
When we began forecasting that the Fed would not cut rates this year and that there was a significant and under-appreciated risk that the Fed might hike rates next year, Breitbart Business Digest was staking out a lonely and contrarian position. The Fed was projecting three cuts, and the market was pricing in five or six.
Even the most steely-eyed inflation raptors had a cut or two built into their projections. We weren’t alone in our view, but it was very much outside of consensus.
Now our view has gone mainstream. The cover story for this week’s Barron’s warns readers: “The Fed Won’t Cut Rates This Year.”
“The Federal Reserve isn’t likely to lower interest rates in 2024. Elevated inflation, a resilient economy, and a still-strong, if softening labor market argue against the need for easing monetary policy, especially as these conditions are expected to persist through year end,” writes Nicholas Jasinski, a senior writer at Barron’s focusing on economics and Federal Reserve coverage.
This leaves us feeling a bit like the kid in school who falls in love with the alternative band no one has ever heard of but then discovers six months later that all the popular kids are wearing the band’s t-shirts. We were into them before they were cool!
The Economy Is Too Hot for Cuts
The Barron’s case for why you should expect the Fed to sit tight and not cut is sound. The center piece is exactly what we have been arguing: “Think of the Fed’s policy stance as higher for longer than almost anyone anticipated, because the U.S. economy has been stronger for longer than almost anyone imagined.”
The Fed’s interest rate policy has weighed on economic growth far less than most economists and financial pundits expected. The widely heralded recession of 2023 never happened, as we correctly predicted. The labor market has remained solid and consumer spending strong. Surveys of consumer sentiment show that people are very unhappy about the economy, but that isn’t causing them to pull back from spending or ratchet up savings as a precaution against a downturn.
As a result, there’s no pressing need for a rate cut. Those who are still pushing for a cut have resorted to saying that the Fed should engage in precautionary cutting. They point out that most economic data is necessarily backward-looking in that it tells us what has happened but not what will happen. So, they want the Fed to make policy based on what they think will happen rather than what has happened or is happening now.
It’s true that forward-looking indicators—such as the yield curve and the index of leading indicators—tell a bleak story about the future. But they’ve been telling that story for nearly two years. At this point, they are most useful as a reminder that the economy is operating very differently than it has in the past rather than as signals about what to expect next.
The other big argument for rate cuts has to do with real interest rates, which is interest rates after inflation. It goes like this: when inflation falls, real interest rates increase mechanically, tightening monetary policy. So, if the Fed does not cut, then real rates are in danger of increasing, causing monetary policy to tighten without Fed action.
The trouble with this is that inflation also rises. Real interest rates fell at the start of this year because inflation rose. And suddenly all those voices telling us to watch real rates went quiet. It’s enough to make you think that the real rates argument started from the conclusion that the Fed should cut rather than being a product of dispassionate analysis.
Building the Case Against Cuts
Today’s construction spending data should be another blow to the view that rates are sufficiently restrictive, much less that the Fed should be cutting. While overall spending fell, contrary to Wall Street’s expectation for a small rise, single family home construction—the most interest rate sensitive segment of building—ticked up a tenth of a percentage point. Compared with a year ago, it is up 20.4 percent.
(Photo: Jens Behrmann/Unsplash)
What’s more, there’s clear evidence that government spending is still stepping on the economic accelerator. Construction spending for manufacturing plants rose 0.9 percent in April and is up 17.1 percent from a year ago. Much of this is due to spending incentivized and subsidized by the CHIPS Act and the Inflation Reduction Act.
Yet the allure of rate cuts remains. Morgan Stanley reiterated its view on Monday that the Fed will cut three times this year, beginning with a cut in September. While the market sees that as a stretch, it is still pricing in two cuts this year, with better than even odds that the Fed announces the first cut at the September meeting—just eight weeks before election day.
This provides us with some comfort that we’re still safely contrarian—even if Barron‘s now agrees with us. And the data continues to indicate that our view is fundamentally sound.