“If you wait until inflation gets all the way down to 2%, you’ve probably waited too long …” Jerome Powell, The Chair of the Federal Reserve.
There you go; Powell has hinted that the Fed is ready to cut rates even before inflation hits its intended 2% target rate. And it makes sense to do so because inflation data is a lagging indicator. The Fed doesn’t want to overtighten and risk getting the economy into a deep recession.
Where Is Inflation Now?
The latest US CPI reading for June 2024 was 3.0%, and the Core CPI was 3.3%. On a month-to-month basis, the CPI decreased by 0.1% compared to May 2024. This is the first time since 2020 that we had a month-to-month decrease. Awesome!
The chart above shows both the CPI and Core CPI readings since 2021. Inflation has been on a downward trend since 2022. Though not yet, the numbers are getting closer to the Fed’s inflation target of 2%.
Softening Labor Market
Although the labor market was red-hot throughout 2023, we have started to see the crack this year. You may have read news about various industry layoffs, especially in the high-growth tech sector. The joblessness rate began to tick up to 4.1% in June 2024.
The Fed has two mandates: price stability and maximum employment. The Fed seems to be doing a decent job moderating inflation. However, their other scorecard on employment seems to be showing a warning sign, with the job market softening. The turning point is getting closer and closer.
Market Expectation
With the latest inflation and job data, coupled with the Fed’s remark, the market has been expecting the first rate cut to start as soon as September 2024, with further reductions in 2025.
As of 16 July 2024, the market expects a September rate cut at 100% probability, with a 93.3% probability of a 25bps rate cut and a 6.7% probability of a 50bps rate cut!
Remarks
What do you think? Do you agree that the recent economic data supports the thesis of a possible rate cut coming as soon as September 2024? Given the moderating inflation and softening job market, the Fed pivot could be getting closer.
If you agree with this sentiment, now could be the last few months to prepare for the possible upcoming rate cuts.
If you are among those investors seeking capital preservation, locking in the higher rates now could be an option to consider. We have recently migrated a portion of our short-term T-bills allocation into Singapore Savings Bonds (SSB) to enjoy the higher rates for much longer.
When interest rates decline, businesses with higher debt loads feel more of the effect. They need to pay less interest to service their debt, thus increasing their profitability.
In anticipation of future rate cuts, it is common for investors to start shifting their money from businesses with low debt and higher valuations to those with higher debt that are not richly valued.
If you have followed the market, you may have noticed the sector rotation from the cash-rich and high-multiple tech sector (Nasdaq) into REITs, the more defensive sectors such as those under the Dow Jones index, and even the small-cap businesses (Russell 2000).
So, what’s your move?
Happy investing 🙂
