Fed chairman Jerome Powell kicked off his Aug. 22 speech at the annual Jackson Hole Economic Policy Symposium by admitting that the economic outlook may warrant a change in the Fed’s tight money policy. That was Fed speak for it is time to cut interest rates. Markets soared on the news.
Economists will debate endlessly whether Powell’s sudden turnaround reflects the mounting pressure by the administration on the Fed to cut interest rates or worries that unemployment may be rising. In the meantime, all the main averages were up more than 1.5%.
The assumption (more than a 90% chance) is that this first-interest rate cut will occur on September 17, the date of the Fed’s FOMC meeting. The question most are already asking is how many more cuts are in the cards between that meeting and the end of the year. The market believes two more cuts will occur. The next series of economic data points, released before their next meeting, will determine that.
If inflation data comes in higher than expected, then there may be only one cut in September. Readers know that I am expecting hotter inflation readings to continue through the end of the year. Powell seems to be aware of that as well. He said the risks from inflation remain “tilted to the upside.” Like me, he also believes that tariff-related inflation pressures “are now clearly visible.”
Balancing out the inflation risk, however, is the growing unemployment risk. Job risk became a factor after the Bureau of Labor Statistics revealed that unemployment had been ticking up for the last three months. Most analysts believe that the July non-farm payrolls report will also show weakening job growth. The onset of tariffs has made the job of managing monetary policy tricky at best.
Suppose that is the case, why cut interest rates at all? Therein lies the rub. Ostensibly, the fear of further job losses. However, the pressure by the Trump administration to remake the Federal Reserve Bank is growing by the day. By September, if Congress votes to approve Stephen Miran, the president’s Chair of his Council of Economic Advisors, to the Fed, at least three members of the FOMC will be Trump appointees.
Last week, Trump made it clear that he planned to fire Fed Governor Lisa Cook if she doesn’t resign — and he did so this week on Monday — giving him four out of 12 FOMC members in his pocket. It is likely that the president, unless somehow appeased in the short run, will continue to find cause, reasons, or excuses (manufactured or otherwise) to continue his persecution of the remaining Fed members not under his control. From Powell’s point of view, the political circumstances might justify a “hawkish” cut next month to alleviate the pressure. Sort of a cut in time to save nine (FOMC members).
Before Friday, the S&P 500 was down 2.2% last week, while the NASDAQ was lower by 4%. That was the second week in four that markets sold off only to bounce back. However, under the hood, those sectors and stocks that have driven the market’s gains over the last few weeks were trashed.
Investors sold momentum names like Palantir, Tesla, and Nvidia. Other artificial intelligence names took it on the chin, falling by double digits. Some software stocks were down more than 20%. Wall Street bears have long argued that valuations in the AI space are absurd. Companies with little to offer investors beyond some mention of AI in their company name or business saw their stock price triple and quadruple in a matter of weeks.
Bulls say that valuations don’t matter. No one knows how AI power will transform the world’s economies, but they believe that the AI potential must be measured in mega-trillions of dollars. Given that thesis, it was a shock when Sam Altman, the CEO of ChatGPT, one of the movers and shakers behind AI, joined the fray.
He said last week that the billions of dollars flowing into the AI arms race risk causing a bubble comparable to the dot-com crash of the early 2000s. “Are we in a phase where investors as a whole are overexcited about AI? My opinion is yes. Is AI the most important thing to happen in a very long time? My opinion is also yes.”
But Powell’s comments on Aug. 22 effectively dismissed all these misgivings as investors rushed to buy the dip. Interest rate-sensitive sectors and stocks lead the charge higher. Small-cap stocks, as represented by the Russel 200 index (3.87%), outperformed. The dollar fell almost a whole percentage point since expectations of lower U.S. interest rates mean a lower dollar. As such, both gold (+1%) and silver (+2.28%) as well as cryptocurrencies also chalked up some significant wins.
The last few weeks of mild corrective actions have now given way to higher stock prices and possibly another attempt to regain former highs. I could see the S&P 500 Index tack on another 75 points or so to 6,550 -6,570. Are we out of the woods and on our way to the moon? Not yet, I see another decline once we reach my target sometime in September.
Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.
