Rate Cuts Kick Off Continued Record Highs

Quick Take:  As the Fed delivered a surprising 50bps rate cut, stocks reached new heights again while bonds rallied.[1]

Expectations headed into September for market returns were somewhat low, in part because of historical seasonal underperformance.[2] Just a week before the September meeting, investors overwhelmingly expected the Federal Reserve (the Fed) to cut rates by 25bps.[3] However, easing inflation paved the way for the Fed to kick off its first interest rate cut with a bang.[4]  The Fed slashed rates by a jumbo half a percentage point in the first cut since hiking interest rates 11 times in 2022 and 2023.[5]

Source: https://www.reuters.com/markets/us/broadening-gains-us-stock-market-underscore-optimism-economy-2024-09-30/

The big cut in rates sparked a furious rally in stocks, leading traders to bid up tech shares and increase exposure to other risky assets on the view that lower borrowing costs can keep unemployment low without reigniting inflation.[6] Encouragingly, the rally in the third quarter was relatively broad-based instead of being concentrated in just technology names.[7]

An emphatic response to the central bank’s move took the S&P to yet another record high, the first since mid-July.[8] The S&P 500 gained 2% for the month, having advanced 5.53% in the third quarter and 20.81% for the year. [9] Bonds also delivered a strong rally, with Treasuries stretching to a fifth straight monthly gain.[10]

Source: https://www.bloomberg.com/news/articles/2024-09-30/treasury-market-closes-in-on-historic-five-month-winning-streak

Modest Inflation and Slowing Consumer Spending

After peaking at 9.1% mid-2022, annual inflation, according to the consumer price index, dropped to 2.5% in August — the lowest annual increase since February 2021.[11]^,[12] The Fed’s preferred gauge for inflation, the personal consumption expenditures price index, also rose modestly.[13]

Source: https://www.bloomberg.com/news/articles/2024-09-27/fed-s-favored-inflation-gauge-consumer-spending-barely-rise

Armed with better inflation data, the Fed was able to bring the target fed funds rate to 4.75-5%. A tepid increase in real consumer spending underscored just how consumers are becoming more frugal, and spending momentum is slowing.[14] Spending on services, which makes up the bulk of household consumption, rose 0.2% in August, which was the smallest three-month gain since October 2023.[15]

Expectations for November Rate Cut

The 50bps rate cut triggered some speculation that Fed officials might contemplate another large rate cut in November, given muted inflation data and evidence the consumer sector is weakening.[16]

Such expectations were curtailed at the end of September, when Fed chair Jerome Powell said that although interest rates are likely to be lower in the coming months, the cuts are not anticipated to be in large increments if the economy continues as expected.[17] That could mean two more cuts but not more 50bps cuts, according to Powell.[18] Fed projections show that rates may come down by another half percentage point by the end of 2024.[19]

Housing Starts Rebound

As the market highly anticipated rate cuts, mortgage rates declined sharply, with the average 30-year fixed loan down to 6.09%, which is the lowest since February 2023.[20] The expectation of more cuts to come could breathe some life into the market, which has just come off its worst spring selling season in over a decade.[21]

Home buyers have been waiting on the sidelines due to high prices and a shortage of desirable listings.[22] With the housing market on ice because of an affordability crunch, debate has centered around whether rates can drop enough to jumpstart the housing market.[23]  News of a sharp bounce back in housing starts, which rose to the fastest pace since April, provided some positive news for the sector.[24]  New home construction rose by 9.6% in August, but the trend has been rocky as builders try to balance inventory levels with the chance of increased demand from lower borrowing costs.[25]

Building permits, which offer insight into future construction activity, rose by 5%, while single-family authorizations jumped to a four-month high.[26] Single-family home new construction surged nearly 16% for the first monthly advance since February.[27]

Source: https://www.bloomberg.com/news/articles/2024-09-18/us-housing-starts-increase-to-fastest-pace-since-april

With inventories of unsold homes near the highest since 2008, builders may want to see a sustained pick-up in demand before adding to inventory.[28] Nevertheless, it might still be some time before homebuilding contributes to economic growth again, having not done so since the start of this year.[29] For the third quarter, homebuilding is expected to provide a 0.3% drag on GDP, according to the Atlanta Fed.[30]

Source: https://apnews.com/article/economy-growth-inflation-gdp-consumers-federal-reserve-6ac0d113be186b0e1e9e2c85ce927280

Meanwhile, final GDP numbers for the second quarter showed a healthy 3% pace of annual growth, driven by consumer spending and business investment, which was up sharply from the tepid 1.6% growth in Q1.[31]

Looking Ahead

October kicks off the third quarter earnings season, and markets will be watching the data to see if it can support rich valuations in the stock market.[32]

Domestically, the economy is still showing resilience, but recent escalations in Middle East tensions have drawn headlines and concerns that a wider conflict could disrupt crude oil flows from the region.[33] So far, the impact on financial markets has been relatively limited, cushioned by the prospect of monetary policy easing and also the United States’ expanded role in oil production. [34]  The U.S. has been the world’s biggest oil producer for the past six years and has high levels of short-term crude oil inventories, which has lowered global sensitivity to Middle East supply disruptions.[35]

With Election Day approaching, it’s important to note what we’ve seen in the past: history shows that the winning candidate or party often has little long-term impact on market returns, though markets often do react in the short-term.[36] Although it can be unsettling, increased volatility could remain on the horizon.

As we start the final quarter of 2024, keep in mind that short-term volatility can be both distracting and fleeting. Staying focused on long-term goals and maintaining diversification are your best tools to fight any unexpected turbulence. Don’t hesitate to reach out if you have any questions.

Have a wonderful beginning of Fall as we enter into cooler temperatures and the season of giving! If you haven’t yet scheduled your year-end meeting, please reach out to us. We look forward to connecting with you in the coming weeks as the holiday season fast approaches.

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