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Over the past few years, it seems as if markets have been obsessed with Federal Reserve action, first the rate hiking cycle and now quote unquote the inevitable rate cuts. Investors might find it useful to know when is the FED going to start a new cycle of cutting rates. As it turns out, there's specific data you should be looking at to know when that cycle might begin. I'm Barry Ridhelts, and on today's edition of At the Money, we're going to discuss how you can tell when the
Fed is going to start cutting rates. To help us unpack all of this and what it means for your portfolio, let's bring in Jim Bianco, chief strategist at Bianco Research. His firm has been providing objective, an unconventional research and commentary to portfolio managers since nineteen ninety and it's top rated amongst institutional traders. So Jim, let's just start with the basics. How significant are rate cuts or hikes to the typical market cycle?
How much do they really matter?
Thanks for having me, Berry, and the answer is they matter more now than they have, say, over the last fifteen years, for a very simple reason. There is a yield again in the bond market. And as my friend Jim Grant likes to say, who writes the newsletter, Grant's Interest Rate Observer, it's nice to have an interest rate to observe again, And because of that, we've got a
whole different dynamic. Well, in twenty nineteen, when your average money market fund was yielding zero and your average bond fund was yielding two percent, we used to scream, Tina, there is no alternative. You can't sit there in a zero money market fund. You got to move up the risk curve to stocks, and you've got to, you know, try and get some kind of reward from it. Well, in twenty twenty four, now a money market fund is yielding five point three percent and a bond fund is
yielding around four point eight to five percent. Well, that's two thirds of what you can expect out of the stock market. And especially if we wanted to stick with a money market fund and virtually no market risk, because it has an neev of one dollar every day, and there's a fair number of people will say seventy percent, two thirds of the stock market without any risk at all market risk, that is sign me up for that.
So let's talk about raising and lowering rates. I have to go back to twenty twenty two when the Fed began their rate hiking cycle. It seems like a lot of investors were blindsided by what was arguably the most aggressive tightening cycle since since Paul Volker five hundred and twenty five basis points in about eighteen months. Why, given what had happened with CPI inflation spiking, why were investors so blindsided by that.
They had gone forty years without seeing inflation and they couldn't believe that inflation was going to return. And the typical economist actually was arguing that there is no more inflation again. And I might add to this day, the typical economist still argues that we don't have inflation.
Now.
I'm fond of saying that the term two things could be true at once. And what you saw in twenty twenty two, twenty twenty one, and twenty two two is transitory inflation that got us to nine percent on CPI. But once that transitory element of nine percent is settled out, what I believe we're starting to see more and more of is there is a new underlying higher inflation level. It is not two percent, It is more like three to four percent inflation, not as I like to say,
it's not eight ten or Zimbabwe. It's three to four percent. And that three to four percent is what's got the Fed slow in cutting rates. It's got people debating whether or not interest rates should come down more or go up more. So, yes, we had transitory inflation because of the lockdowns and the supply train constraints, and that has gone away, but left in its wake is a higher level of inflation, and that is the debate that we're
having right now. And if we have a higher level of inflation, that is going to weigh heavily on monetary policy.
He hadn't done them any good.
So in the mid nineties, where were rates? How high had they gone up? And then how much lower had the Fed taken them?
So they were at six percent at their peak in late nineteen ninety four, and the Fed started to cut rates and then they eventually wound up a cutting them all the way down to three percent. At that point, we thought that three percent was a microscopically low interest rate.
We know what we were in star Forth over the next twenty years, So those rates were not very different than the rates that we're seeing today with the FED being a five to five and a quarter and with the bond with the yield and the ten year Treasury at around four fifteen to four twenty, so we're kind of in the same range that we've seen that.
So if I'm an investor and I want to know the best data series to track and the levels to pay attention to, that are going to give me a heads up that, hey, the FED is really going to start cutting rates. Now what should I be looking at
and what are the levels that suggest? Okay, now the FED is going to be comfortable, maybe not cutting them in half the way they did in the mid nineties, but certainly taking rates from five to five and a quarter down to four to four and a quarter four and a half something like that.
So one forward looking measure and one kind of backward looking measure that matters for the FED. The forward looking measure is going to be probably the labor market. What the FED is most concerned about is higher interest rates. Are they going to weigh on business borrowing costs and reduce their propensity or willingness to continue to hire workers. So let's look at the initial claims for unemployment insurance. It's a number that's put out every Thursday for the
previous week initial claims. Everybody has unemployment insurance. It's a state program BUERAFU label. Statistic just aggregates to fifty states and puts out that number on a seasonally adjusted basis. It's in the low two hundred thousands right now. That is over the last fifty years, an extraordinarily low number, you start to and so if it goes up to two twenty five or two forty, it's still a low number.
I think if you start seeing it, you know, start pushing two seventy five or above three hundred thousand, are that means new recipients for unemployment insurance that week? Then I start thinking that, you know, there is a real problem starting to brew in the labor market. The Fed will see that too, and the propensity for them to cut will grow. And I want to emphasize here two hundred thousand on Wall Street tends to kind of get
themselves myopic. Here, Oh, it went from two hundred thousand to two hundred and twenty five, two hundred and thirty thousand.
The labor market is weakening.
No, that's all noise down near the lowest numbers that we've ever seen in fifty years. It's got to do something more significant than that.
What's the best inflation data to track that? You know, Jerome Powell is paying attention to.
So Pow likes this obtuse number. He likes it because he made it up called cores supercore. So it's it's it's inflation less house excuse me, less food, less energy, and less housing services. Now before you roll your eyes and go, so you're talking about inflation provided I don't eat, I don't drive, and I don't live anywhere. Inflation ex inflation right right, what's left over is driven by wages. And why he looks at that is he's trying to say, are we seeing a wage spiral?
Now? Why is a wage spiral important?
No one is against anybody getting a raise, But the fact is, if everybody is getting a four percent raise, you can afford three to four percent inflation. If everybody's getting a five percent raise, you can afford four percent inflation. And that's what they're most concerned about, is getting that inflation spiral going with a wage spiral. So they look at the super core number as a way to say, yes,
we understand that there's housing. We understand that there's driving, we understand that there's eating, and there's inflation in those three. But we also understand that there's way inflation in wages. And that's what they're trying to do is look at wages, and so that's probably the best measure to look at.
So I know what a data wonk and a market historian you are, but I suspect a lot of investors, a lot of listeners, may not know what happens to the bond market and the equity market once the Fed finally begins cutting rates.
It depends on why, because there's two scenarios in there. If the Fed starts cutting rates like it did in twenty twenty, or like it did in two thousand and eight, or like it did even in two thousand and one, and it's a panic, Oh my god, the economy is falling apart. People are losing their jobs. We've got to start to stimulate the economy. We have to stop a recession. If they're cutting rates because of a panic, it doesn't work.
We had recessions every time they started doing that, last one being twenty twenty when they saw what was happening with COVID, and because it is projecting a recession, which means less economic activity, lower earnings. It's usually a difficult period for risk markets like the stock market or real estate prices and the like. If the Fed is cutting rates like they did in nineteen ninety five or like they did in twenty nineteen, it's kind of a victory lap.
We did it.
We stopped the bad stuff from happening, our magic tool of interest rates, accomplished everything that we need. Now we don't need a restrictive rate anymore, and they back off of that restrictive rate. Well ninety five and twenty nineteen, risk markets took off. Now twenty nineteen was short lived because then COVID gotten away, and that was an exogenous event that was not financially related. But they were going right up until the moment that COVID hit. So why
is the Fed cutting rates? It really matters more than when will they cut rates? And right now what everybody's hoping for is the why will be a victory lap. We did it, We stopped that bad old inflation. It's gotten back to our two percent target. We could go back to the way we were pre pandemic. And then once we're there. We could now start to back off
of this restrictive rate and everybody will celebrate that. Yay, we're getting into straight relief without it being a signal that the economy is falling.
So to wrap up, investors hoping for rate cuts should be aware that sometimes there's a positive response when it's a victory lap. Sometimes when it's revealing the economy is softening or a recession is coming, tends not to be good for stocks. Volatility tends to increase. It's a classic case of be careful what you wish for. But if you want to know what the Fed is going to do, you should keep track of initial unemployment claims. When they get up towards three hundred thousand per week, that's a
warning sign. And follow Chairman Pal's super core Inflation, where he's looking at the rate of wage increases to determine when the Fed begins its newest rate cutting cycle. I'm Barry Retults and you've been listening to Bloomberg's at the Money, got.
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