TKer: 'How many times will the Fed cut rates?' is not the right question

But the world is complicated, and all other things are never equal.

The Fed’s decisions on monetary policy — as well as the market’s expectations for those decisions — do not occur in a vacuum. They occur in the context of everything happening in the economy.

The economy has been exceeding expectations. And better-than-expected economic results help explain better-than-expected earnings growth, and earnings are the most important driver of stock prices. These indicators are not bearish.

We had a very similar discussion a year ago in the Jan. 28 TKer: “Whether or not the Fed cuts rates is not the right question“

At the end of 2023, the markets were convinced the Fed would make its first rate cut of the cycle in March 2024. However, those odds tumbled as the economic data rolling in far exceeded expectations.

Here’s what I said to Investopedia’s Caleb Silver at the time:

… As far as whether or not they actually pivot and begin to cut or hold or whatever, I think that’s really not the right question. The question [should] be, “If they don’t cut, then why are they not cutting as they suggested in their dot plots?” Right? Is it possible that the economy heats up more than they initially modeled? Yeah, maybe that’s a good reason to not cut because they’re concerned that inflation is going to be bubbling up again.

From an investor perspective and from an economic perspective, that’s not exactly the worst thing in the world that the economy isn’t falling apart. Because remember, a lot of these assumptions when it comes to the Fed pivot, in addition to inflation cooling, are also tied to the idea that the economy is also cooling — that growth is slowing and decelerating and that a lot of people have recessions on their mind. So maybe the Fed doesn’t pivot because the economy’s picking up. That’s really not that big a deal.

As we now know, that initial rate cut got pushed back all the way to September.

Importantly, the stock market continued to trend higher during this period.

As much as everyone wants to avoid economic crises, history suggests they’re unavoidable. So there may eventually come a time when Fed policy decisions have a more significant impact on the outlook for markets.

But for now, monetary policy is just one of many things that can move markets.

“For U.S. equity returns, policy moves take a backseat to the scarcity or abundance of corporate profits,” BofA’s Savita Subramanian said in September.

This speaks to TKer Stock Market Truth No. 5: “News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.”

And currently, the outlook for earnings growth remains favorable.

There were several notable data points and macroeconomic developments since our last review:

Unemployment claims fall. Initial claims for unemployment benefits fell to 211,000 during the week ending December 28, down from 222,000 the week prior. This metric continues to be at levels historically associated with economic growth.

Consumer vibes deteriorate. The Conference Board’s Consumer Confidence Index ticked lower in December. From the firm’s Dana Peterson: “While weaker consumer assessments of the present situation and expectations contributed to the decline, the expectations component saw the sharpest drop. Consumer views of current labor market conditions continued to improve, consistent with recent jobs and unemployment data, but their assessment of business conditions weakened. Compared to last month, consumers in December were substantially less optimistic about future business conditions and incomes. Moreover, pessimism about future employment prospects returned after cautious optimism prevailed in October and November.”

Consumers feel better about the labor market. From The Conference Board’s December Consumer Confidence survey: “Consumers’ appraisals of the labor market improved in December. 37.0% of consumers said jobs were ‘plentiful,’ up from 33.6% in November. 14.8% of consumers said jobs were ‘hard to get,’ down from 15.2%.”

Many economists monitor the spread between these two percentages (a.k.a., the labor market differential), and it’s been reflecting a cooling labor market.

Card spending data is holding up. From JPMorgan: “As of 21 Dec 2024, our Chase Consumer Card spending data (unadjusted) was 2.1% above the same day last year. Based on the Chase Consumer Card data through 21 Dec 2024, our estimate of the US Census December control measure of retail sales m/m is 0.82%.”

Mortgage rates tick higher. According to Freddie Mac, the average 30-year fixed-rate mortgage rose to 6.91%, up from 6.85% last week. From Freddie Mac: “Inching up to just shy of seven percent, mortgage rates reached their highest point in nearly six months. Compared to this time last year, rates are elevated and the market’s affordability headwinds persist. However, buyers appear to be more inclined to get off the sidelines as pending home sales rise.”

There are 147 million housing units in the U.S., of which 86.6 million are owner-occupied and 34 million (or 40%) of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.

Home prices rise. According to the S&P CoreLogic Case-Shiller index, home prices rose 0.3% month-over-month in October. From S&P Dow Jones Indices’ Brian Luke: “Our National Index hit its 17th consecutive all-time high, and only two markets – Tampa and Cleveland – fell during the past month. The annual returns continue to post positive inflation-adjusted returns but are falling well short of the annualized gains experienced this decade. Markets in Florida and Arizona are rising, but not keeping up with inflation, and are well off the over 10% gains annually from 2020 to present. This has allowed other markets to catch up.”

New home sales rise. Sales of newly built homes jumped 5.9% in November to an annualized rate of 664,000 units.

Construction spending ticks higher. Construction spending increased modestly to an annual rate of $2.15 trillion in November.

Manufacturing surveys could be better. From S&P Global’s December U.S. Manufacturing PMI: “US factories reported a tough end to 2024, and have scaled back their optimism for growth in the year ahead. Production was cut at an increased rate in December amid disappointing inflows of new orders. While November had seen a near-stabilization of order books as uncertainty surrounding the election passed, reviving customer demand, this respite has proved temporary. Factories are reporting an environment of subdued sales and inquiries, notably in terms of exports. Many firms are generally anticipating that business will pick up in the New Year, with respondents pinning hopes on expectations that the new administration will loosen regulations, reduce tax burdens and boost demand for US-made goods via tariffs.”

The ISM Manufacturing PMI improved in December but continued to signal contraction in the sector.

Keep in mind that during times of perceived stress, soft survey data tends to be more exaggerated than actual hard data.

Most U.S. states are still growing. From the Philly Fed’s November State Coincident Indexes report: “Over the past three months, the indexes increased in 39 states, decreased in 10 states, and remained stable in one, for a three-month diffusion index of 58. Additionally, in the past month, the indexes increased in 31 states, decreased in 15 states, and remained stable in four, for a one-month diffusion index of 32.”

Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.4% rate in Q4.

The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. And earnings are the most important driver of stock prices.

Demand for goods and services is positive, and the economy continues to grow. At the same time, economic growth has normalized from much hotter levels earlier in the cycle. The economy is less “coiled” these days as major tailwinds like excess job openings have faded.

To be clear: The economy remains very healthy, supported by strong consumer and business balance sheets. Job creation remains positive. And the Federal Reserve — having resolved the inflation crisis — has shifted its focus toward supporting the labor market.

We are in an odd period given that the hard economic data has decoupled from the soft sentiment-oriented data. Consumer and business sentiment has been relatively poor, even as tangible consumer and business activity continue to grow and trend at record levels. From an investor’s perspective, what matters is that the hard economic data continues to hold up.

Analysts expect the U.S. stock market could outperform the U.S. economy, thanks largely due to positive operating leverage. Since the pandemic, companies have adjusted their cost structures aggressively. This has come with strategic layoffs and investment in new equipment, including hardware powered by AI. These moves are resulting in positive operating leverage, which means a modest amount of sales growth — in the cooling economy — is translating to robust earnings growth.

Of course, this does not mean we should get complacent. There will always be risks to worry about — such as U.S. political uncertainty, geopolitical turmoil, energy price volatility, cyber attacks, etc. There are also the dreaded unknowns. Any of these risks can flare up and spark short-term volatility in the markets.

There’s also the harsh reality that economic recessions and bear markets are developments that all long-term investors should expect to experience as they build wealth in the markets. Always keep your stock market seat belts fastened.

For now, there’s no reason to believe there’ll be a challenge that the economy and the markets won’t be able to overcome over time. The long game remains undefeated, and it’s a streak long-term investors can expect to continue.

A version of this story first appeared on TKer.co