Yesterday was the FOMC announcement day. This is the rate cut meeting people have been looking forward to. To many people’s surprise, the Fed didn’t just cut 25bps. They started their rate cut cycle with a big fat 50bps cut. In the FOMC statement above, the Fed expressed concerns on the labor market and their confidence of getting inflation under control. But the 50bps cut signals that the Fed is quite concerned about the current state of the economy and wants to act more aggressively to relieve some pressure.
For the September meeting, they also published the dot plot projections. It appears the median projections have moved quite a bit since the June meeting. The expected Fed Funds Rate is revised down to 4.4% from 5.1% by the end of 2024 and the rate is revised down from 4.1% to 3.4% by the end of 2025. The projected unemployment rate was revised up and core PCE was revised down. It’s quite interesting how much the FOMC members shifted their opinions in just a few months. I wonder what kind of data they have been seeing?
I still think that the rate cut cycle can cause quite a bit of chaos, especially if the rates go down too fast. A lot of money was flowing into the US dollars because people can borrow at cheap rates like sub 2% in Asia/Japan, convert the local currencies to US dollars and get a 5% risk-free return. Not everyone will do this kind of carry trade but AFAIK, many foreigners convert their local currencies to USD to earn a better yield. But if the rate goes below say 3%, the incentive will no longer be there and we might see the US dollar devalue a bit. I personally earn quite a bit of income from treasury bills these days and this interest income definitely boosts my personal consumption. But if the rates go below 3%, chances are I will start to cut back. I am building a small collection of musical instruments. If I have a lot of interest income, I buy more. Otherwise, I buy less. In 2023, the US treasury paid out $658B of interest and they are projected to pay out $892B in 2024. That’s $230B+ of additional cash into Treasury investors’ pocket and roughly 1% of US GDP. (Remember this is all deficit spending. It’s not like the US actually balances its budget.) The rate cuts can potentially have a negative effect on consumer spending. If the US dollar devalues, money might start leaving the US stock markets causing a correction and with less interest income paid out from the Treasury, consumer spending could start to slow. In general, I am a bit bearish in the short term. But the bigger wildcard is actually the election results. There’s a wild range of outcomes depending on who gets elected as the president and who gets the control of the Senate and the House. I think the election results will affect what’s to come in the next four years including tech, monetary and immigration policies and we won’t really get any clarity until after the November election.
