Brooke Thackray outlines his takeaways from yesterday's Fed decision
The US Federal Reserve’s decision to hold interest rates steady yesterday came in as expected. Despite cooling inflation and some uptick in the unemployment rate, Fed chair Jerome Powell does not yet see enough data to give him confidence for a cut. He did, however, make a clear signal that a cut should come in September provided the current trends hold firm.
Brooke Thackray sees this response as dovish. The research analyst at Global X Canada explained why he saw a shift in the Fed’s focus and language away from concerns about inflation towards concerns about unemployment. He outlined why he thinks the Fed is very likely to cut at the September meeting, why markets may experience some initial euphoria as a result, and why advisors should be preparing their clients for the onset of yet more volatility.
“Powell has set the table for a cut, but he hasn’t called dinnertime yet,” Thackray says. “He’s trying to leave the door open, talking about data dependency before making a call and setting the date. But he has set the table for a cut to take place. It won’t be a big surprise that they cut, they don’t want to move from restrictive language to a cut immediately. They’ve been telegraphing, they’re preparing for this. Unless we see inflation skyrocketing up, I expect the Federal Reserve will cut in September.”
Key to Thackray’s outlook is Powell’s shift in language toward the other side of his dual mandate – balancing inflation and unemployment. The language accompanying the cut was more focused on unemployment concerns. While topline unemployment is historically low in the United States, it is moving higher. Thackray also notes that certain sectors have struggled more and underlying numbers may give the Fed reason to worry about unemployment.
Underlying numbers around GDP, inflation, and other key metrics may also play a key role in determining the course of monetary policy. The dramatic whiplash impacts of the COVID-19 pandemic have introduced many abnormal dynamics in the US economy. Including a degree of stimulus that largely landed in the upper quintile of earners, because of their tendency to own businesses. Lower quintile earners have been struggling for a while now, having eaten through their ‘excess savings’ from the pandemic. The lagging impact of interest rate hikes may add to those struggles and result in a deeper slowdown than some anticipate. Interest rate cuts may be key to keeping the US on course for a soft landing.
The Fed’s decision to hold in July, Thackray says, should not deter the Bank of Canada from cutting interest rates again in September. That’s because the Canadian economy is simply weaker than its US equivalent. While some have raised concerns that the BoC may diverge too much from the Fed, which could impact CAD, the table setting that Powell has done here should give BoC Governor Tiff Macklem more confidence about a third consecutive cut in September.
The initial market reaction to this dovish hold has been positive. Typically, Thackray says, investors cheer the onset of a rate cutting cycle and greet bad economic news — such as falling GDP growth or rising unemployment — as good news because it brings cuts. After a certain point in the cutting cycle, however, the fact of a slowing economy begins to be seen in earnings. At that point, bad news becomes bad news and investors become more risk averse. While Thackray sees a short-term rally as likely, he thinks that an already expensive US equity market may not have much more room to run as the US economy slows.
In a market that has been driven by macro narratives for several years now, advisors have the difficult job of providing context to their clients and preparing them for future volatility. Thackray believes that in this environment an approach based on prudence and caution can help demonstrate value.
“I wouldn’t jump on board and make huge changes in the portfolio and say that interest rate cuts are the green light to have huge returns,” Thackray says. “I would say they should be fairly balanced in their approach and insetting expectations. The expectations would be that there may be a bump in the markets here, but I wouldn’t see that as a multi-year rally. This is not the time to make a decision that dramatically shifts your portfolio because of an action by a central bank.”
