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Who Benefits from the Federal Reserve’s Decisions? Examining the Impacts of Potential Rate Cuts
Who does the Fed truly serve?
This question emerged from veteran trader Jeff Clark during a recent investment conference in Baltimore, where discussions featured key players from InvestorPlace and TradeSmith, including CEO Brian Hunt and Chief Investment Officer Charles Sizemore.
After Sizemore outlined Federal Reserve Chairman Jerome Powell’s errors in past years, Clark took a moment to reflect before asking: If the Fed serves the people, sure, there have been missteps. But if they serve the Big Banks, it’s business as usual.
This inquiry highlights an ongoing debate about the Federal Reserve’s priorities, and we will delve deeper into it shortly.
What to Expect from the Fed’s Upcoming Interest Rate Decision
As I compose this on Monday morning, the CME Group’s FedWatch Tool indicates a 95.4% chance of a quarter-point rate cut during the December Federal Open Market Committee (FOMC) meeting this Wednesday.
The Fed often emphasizes that its decisions are “data dependent,” which raises concerns about another rate cut at this juncture.
While it’s important to acknowledge the Fed’s challenging role in balancing economic stability—ensuring rates are low enough to protect jobs but high enough to control inflation—many argue that inflation poses the greater threat currently. Thus, cutting rates on Wednesday could be counterproductive unless other interests are influencing the decision.
Analyzing Inflation Trends and the Fed’s Decision-Making
To evaluate the Fed’s reasoning, let’s look at the core personal consumption expenditures (PCE) index, which is its favored measure of inflation. The data from the past six months (with November’s report due this Friday) suggest that inflation remains elevated:
May: 0.1%
June: 0.2%
July: 0.2%
August: 0.2%
September: 0.3%
October: 0.3%
Given this upward trend, is there a genuine need for a rate cut?
If you believe there is, let’s consider another point.
Recent Inflation Reports Raise Further Concerns
The latest Consumer Price Index (CPI) and Producer Price Index (PPI) data does not indicate significant progress on inflation control. The CPI was up by a forecasted 0.3% month-over-month, marking the fastest increase since April. Year-over-year, it soared to 2.7%, significantly above the Fed’s 2% target.
Despite this, the market seemed unfazed last Wednesday. However, the Thursday release of the PPI showed a year-over-year increase of 3.0%, an unexpected rise from 2.4% in October, while the core PPI climbed to 3.4% from 3.1%.
Given these numbers, is a rate cut on the horizon logical?
If your response is “yes,” let’s discuss further.
Real-Time Indicators Suggest Inflation is Rising
Truflation, a real-time inflation measure, currently indicates an inflation rate of 3.00%, which is 50% above the Fed’s target. Bond expert Jim Bianco pointed out this disconnect, questioning whether the markets should be worried about a 99% chance of another rate cut.
Revisiting Jeff Clark’s question, could this situation imply that the Fed is prioritizing the interests of its true benefactors: the banks?
Understanding the Banks’ Interest in Lower Rates
During the pandemic, banks redirected over $2 trillion into investment securities, a 50% increase, due to a lack of profitable lending opportunities. When the Fed initiated an aggressive rate-hiking strategy, the value of these long-term investments suffered dramatically, leaving banks with substantial unrealized losses.
As illustrated below, the chart tracks unrealized losses on available-for-sale securities and held-to-maturity securities dating back to 2006.
Source: FDIC
In the second quarter of 2024, U.S. banks reported $512.9 billion in unrealized losses on investment securities.
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Bank Losses on the Rise: Will the Fed Cut Rates Again?
Financial analysts are closely monitoring the striking reality of unrealized losses faced by banks today. Current stats reveal these losses are seven times greater than what we saw at the height of the 2008 Financial Crisis, marking the 11th straight quarter of unrealized losses in the banking sector.
Understanding the Impact of High Interest Rates
High interest rates can be a double-edged sword for banks. While they enhance the net interest margins, they also lead to fewer loan originations, increased deposit costs, and worries about credit quality. This conundrum is likely a factor in Bank of America’s CEO Brian Moynihan’s calls for the Federal Reserve to lower interest rates. He believes that such a move would ease financial pressures on both banks and consumers.
Moynihan argues that reducing rates could help stabilize bank earnings amid what he describes as a “softening economy.” He emphasizes that lower rates might provide relief for consumers facing burdensome loan payments, while also encouraging businesses to maintain investment levels.
However, the urgency for rate reductions raises questions about Bank of America’s overall financial health, especially considering its staggering $85.7 billion in unrealized bond losses—the highest recorded in the industry.
Fed’s Stance on the Economy and Labor Market
Contrary to Moynihan’s perspective, Federal Reserve Chairman Jerome Powell and several Fed presidents are conveying a sense of assurance about the economy. Powell asserted at a recent event that the U.S. economy is maintaining solid footing, warranting a cautious approach as the Fed seeks a neutral policy rate.
Cleveland Fed President Beth Hammack noted that focusing excessively on isolated job reports can be misleading. She remarked that overall trends suggest the labor market is beginning to adjust favorably post-pandemic.
Chicago Fed President Austan Goolsbee maintained a similar stance, highlighting that although last month’s job gains exceeded his expectations, the labor market had reached a state of “sustainable full employment.”
Moreover, Fed Governor Michele Bowman indicated that the strength within the labor market remains more robust than she initially expected, attributing recent upticks in unemployment primarily to declining hiring rates rather than layoffs.
A significant shift in the investment landscape could arise as President-elect Trump positions himself to implement tax cuts and deregulation, aiming to invigorate economic growth. Business leaders express optimism following his re-election, anticipating favorable changes that will spur thorough investment.
According to Axios, around 80% of CEOs surveyed predict increased sales in the next six months, a rise from 71% last quarter. Furthermore, over 40% of executives are planning to boost capital spending, up from 35% previously.
This surge of investment could potentially increase money circulation, creating upward pressure on inflation, despite expectations that rising productivity will offset these price increases. However, concerns linger about the risk of reinflation, particularly as economic conditions evolve into 2025.
Market projections indicate that the Fed may implement another quarter-point cut, a move that aligns with banks’ preferences, yet it could conflict with consumer interests, especially regarding grocery costs.
Market Outlook and Future Considerations
Despite uncertainties regarding long-term outcomes, a combination of lower interest rates, growing corporate confidence, and planned increases in capital expenditures seems to sustain market enthusiasm as we head into 2025. Investors are urged to remain cautious with stop-loss orders, prudent position sizing, and diversified portfolios while navigating this bullish market.
Engagement from readers is welcomed. Share your thoughts regarding the Federal Reserve’s decisions and their implications by emailing us at Digest@InvestorPlace.com. As the Fed deliberates potential rate cuts, positioning strategies will be essential.
Best regards,
Jeff Remsburg
