Federal Reserve Chairman Jerome Powell answers a question from a reporter during a press conference following a Federal Open Market Committee meeting at the William McChesney Martin Jr. Federal Reserve Building on July 31, 2024 in Washington, DC.
Andrew Harnick | Getty Images
In the eyes of the market, the Fed finds itself either poised to avoid a recession or doomed to repeat the mistakes of its recent past — when it was too late to see the coming storm.
The response from Federal Reserve Chairman Jerome Powell and his colleagues is likely to be crucial in determining how investors navigate such a turbulent climate. Wall Street has been on a wild ride over the past few days, with Tuesday’s upbeat sentiment helping to mitigate some of the damage since recession fears escalated last week.
“In short, there is no recession today, but a recession is increasingly inevitable by year-end if the Fed fails to act,” Steven Blitz, chief U.S. economist at TS Lombard, said in a note to clients. “But it will, starting with a (half-percentage point) cut in September and then announcing it in late August.”
Blitz’s comments reflect the sentiment on Wall Street — there is little sense that a recession is inevitable unless, of course, the Fed fails to act. Then the odds are high.
Disappointing economic data recently has raised concerns that the Fed missed an opportunity at its meeting last week to send a clearer signal that easing was on its way, if not an outright rate cut. That helped evoke memories of the not-so-distant past when Fed officials dismissed the 2021 surge in inflation as “transitory” and eventually pushed through a series of aggressive rate hikes.
Now, with a weak July jobs report and growing concerns about an economic slowdown, the investment community wants the Fed to take strong action before it's too late.
Traders are pricing in a strong chance of a half-percentage-point rate cut in September, followed by a sharp easing that could take the short-term borrowing rate down 2.25 percentage points by the end of next year, as shown by 30-day Fed funds futures. The Fed currently targets a target range of 5.25% to 5.5%.
“The unfortunate reality is that a set of data confirms what the rising unemployment rate now clearly suggests — that the U.S. economy is at best at risk of falling into recession and at worst already in recession,” wrote Andrew Hollenhorst, an economist at Citigroup. “The data over the next month is likely to confirm the continued slowdown, making a September rate cut likely and a cut likely between meetings.”
Emergency relief unlikely
With the economy continuing to create jobs and stock market averages near record highs, despite the recent sell-off, an emergency cut between now and the FOMC meeting on September 17-18 seems unlikely, to say the least.
But the very fact that this is being talked about suggests the depth of recession fears. In the past, the Fed has made only nine such cuts, all under intense pressure, according to Bank of America.
“If the question is, ‘Should the Fed consider cutting rates between meetings now?’ we think history says, ‘No, not even soon,’” said Michael Gapen, an economist at Bank of America.
But in the absence of a catalyst for a rate cut between meetings, the Fed is expected to cut rates at the same pace it raised them between March 2022 and July 2023. The bank could begin that process later this month, when Powell delivers his much-anticipated policy speech at the Fed’s annual retreat in Jackson Hole, Wyoming. Powell is already expected to signal how the easing path will evolve.
Joseph LaVorgna, chief U.S. economist at SMBC Nikko Securities, expects the Fed to cut rates by a full 3 percentage points by the end of 2025, which would be more aggressive than current market expectations.
“Either you inflate interest rates or you go home. The Fed has made it clear that interest rates are too high. Why is it slow to remove tightening? It will rush to cut rates for one reason only: interest rates are not at the right level. Why wait?”
But LaVorgna isn’t convinced the Fed is fighting a life-or-death battle against recession. But he said “normalizing” the inverted yield curve, or getting longer-dated securities back to yield higher returns than their shorter-dated counterparts, would be key to avoiding a downturn.
Over the weekend, Goldman Sachs drew some attention when it raised its recession forecast, but only to 25% from 15%. However, the bank noted that one reason it doesn’t think a recession is imminent is that the Federal Reserve has plenty of room to cut interest rates — by 5.25 percentage points if necessary — not to mention the ability to restart its bond-buying program known as quantitative easing.
However, any data shocks, such as Friday's negative surprise in nonfarm payrolls numbers, could quickly reignite talk of a recession.
“The Fed is as far behind the economic curve now as it was behind the inflation curve in 2021 and 2022,” economist and strategist David Rosenberg, founder of Rosenberg Research, wrote Tuesday. The growing expectations for rate cuts “foreshadow a real recession scenario because the Fed has rarely done so in the absence of a formal recession — heading into a recession, already in one, or struggling to get out of one,” he added.
