The Evolving Landscape for Rate Cuts

Dr. Jeffrey Roach | Chief Economist

Last Updated:

Key Takeaways

  • The Federal Reserve (Fed) often cuts rates just before the economy enters a recession.
  • Slowing consumer spending preceded most rate cuts throughout history.
  • The mid-1990s were an anomaly — lower interest rates spurred consumer spending, and the economy did not experience a recession.
  • The uncertainty surrounding inflation, growth, and the path of interest rates creates an “evolving situation.”

The Evolving Situation

In Fed Chairman Jerome Powell’s speech during this year’s Jackson Hole Economic Symposium, investors got a stark reminder that the uncertainty around inflation and the labor market makes for “an evolving situation.” The market’s perception is the downside risks to the labor market appear more important than the upside risk to inflation in the medium-term. So therefore, markets are pricing in an aggressive rate-cutting campaign over the course of the next 18 months. Recent data from the Conference Board makes the case that the job market could deteriorate quickly and decisively.

Jobs Not So Plentiful

Consumer confidence improved in August, but consumers are feeling the cold shoulder in the job market. Confidence rose to its highest since February, as inflation expectations improved. Inflation expectations fell to their lowest since the onset of the pandemic as consumer prices have moderated in recent months.

We are observing weakening perceptions about the job market, likely putting a crimp on consumer spending in the coming months. Investors recently heard from companies that consumers are becoming more selective, looking for deals and discounts. Offsetting this potential weakness is the Fed pivot, which could positively impact risk appetite. We expect the Fed to be especially watchful over labor market conditions and could cut aggressively should conditions warrant.

Volatility Comes with Policy Changes

As policy adapts to economic conditions, bond market volatility often rises. The MOVE index — Merrill Lynch Volatility Estimate — is a measure of implied volatility of Treasury options and during periods of rate changes, implied volatility rose. Even during the mid-1990s, when the Fed was able to orchestrate a soft landing, investors dealt with fixed income volatility.

Rate Cuts Often Accompany Economic Weakness


Source: LPL Research, Bank of America Merrill Lynch, Bureau of Labor Statistics, Federal Reserve Board, 08/28/24
Disclosures: Indexes are unmanaged and may not be invested into directly.

Summary

According to the Conference Board, labor market conditions deteriorated in August and a weaker job market will likely be a key reason the Fed will consistently cut rates through the balance of this year. The August payroll report will be published on September 6, and investors should anticipate some underlying weakness in the broader hiring trends, whether it’s this month or in the months ahead. Further, consumers are getting more cautious about buying big-ticket items as the economy progresses into late-cycle dynamics. From an investment perspective, LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its modest overweight to fixed income, funded from cash, which can help buffer against equity market volatility should economic conditions worsen, while also providing attractive income.

Important Disclosures

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

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Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

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Dr. Jeffrey Roach

Jeffrey Roach guides the overall view of the economy for LPL Financial Research and has over 20 years of experience in investing and economics.