Fed SHOCK incoming as markets brace for hawkish rate cut

Key Concepts

• Federal Reserve (Fed) Rate Decision: The central bank's decision on interest rates, a significant event for financial markets.
• Basis Points (bps): A unit of measure equal to one-hundredth of a percentage point (0.01%).
• Hawkish Cut: A rate cut accompanied by commentary suggesting a cautious or restrictive future monetary policy.
• Dovish Policy: Monetary policy aimed at stimulating the economy, typically through lower interest rates and increased liquidity.
• Neutral Policy Rate: The theoretical interest rate that neither stimulates nor restricts economic growth.
• FOMC (Federal Open Market Committee): The body within the Federal Reserve that sets monetary policy.
• Dot Plot: The FOMC's projections for future interest rates, indicating individual members' expectations.
• Balance Sheet Policy: The Fed's management of its assets and liabilities, which can influence liquidity in the financial system.
• Labor Market Data: Information regarding employment, wages, and labor force participation, crucial for Fed policy decisions.
• ADP Numbers: Private sector employment data released by Automatic Data Processing, often a precursor to official government jobs reports.
• Labor Force Participation Rate: The percentage of the working-age population that is either employed or actively seeking employment.
• Structural Reform: Significant changes to the fundamental operations or focus of an institution.
• Pro-growth Policy Bias: Economic policies designed to encourage economic expansion.
• Inflation: A general increase in prices and decrease in the purchasing value of money.
• AI (Artificial Intelligence): Technology that enables machines to perform tasks that typically require human intelligence.
• Generative AI: A type of AI that can create new content, such as text, images, or code.
• Machine Learning: A subset of AI that allows systems to learn from data without explicit programming.
• Corporate Profitability: The ability of a company to generate profits.
• Liquidity: The availability of cash or easily convertible assets in the financial system.
• Affordability Crisis: A situation where the cost of essential goods and services becomes prohibitively high for a significant portion of the population.
• White Knuckle Bull Market: A period of strong stock market gains that is characterized by high volatility and uncertainty.

Federal Reserve Policy and Market Expectations

Futures this morning are indicating a slight decline at the start of trading, with the Dow down 34 points and the Nasdaq down 30 points. A primary driver for this is the rise in interest rates, with the 10-year Treasury yield currently above 4.2%, up two basis points. This movement precedes the Federal Reserve's rate decision at 2:00 PM ET, the final major market event of the year.

The consensus expectation is for the Fed to implement a third consecutive quarter-point rate cut. Fed Chair Jerome Powell is scheduled to speak at 2:30 PM ET, and investors will be closely monitoring his remarks for any indications regarding the future trajectory of rate cuts. Key areas of focus include the Fed's updated "dot plot" (economic projections) and any potential shifts in balance sheet policy.

Kevin Hassett, a leading candidate for the next Fed Chair, has suggested that there is ample room to cut rates by more than 25 basis points.

"Hawkish Cut" Explained

Darius Dale, founder and CEO of 42 Macro, anticipates a "hawkish cut" from the Fed today. This means that while a rate cut is expected, it will be accompanied by commentary that signals a cautious approach to further monetary easing. Dale explains that after today's cut, the policy rate will be at the estimated neutral rate for four FOMC members. Consequently, these members are likely to resist further dovish monetary policy unless significantly adverse labor market data emerges. Dale views such adverse data as unlikely, given his projection that the economy will grow approximately 50% faster than consensus expectations next year.

A "hawkish cut" implies that the Fed will cut rates, but Jerome Powell's subsequent remarks at 2:30 PM ET are expected to temper expectations for future easing, suggesting a prolonged pause. This outlook is not necessarily what the market desires. Despite discussions of a strong labor market, Dale points to concerns about the accuracy of recent job numbers, particularly those reported under the Biden administration, which he describes as "fugazi" (unreliable) due to downward revisions. He also highlights that three out of the last four ADP employment reports have been weaker than expected, and the labor force participation rate remains historically low. From this perspective, a more dovish policy would be preferred to encourage business reinvestment.

The Future of Fed Leadership and Policy

The conversation then shifts to the potential for a change in Fed leadership under a future Trump administration, which is likely to result in lower interest rates. Dale agrees, emphasizing the importance of focusing on structural reforms at the Fed. He believes the institution is poised to pivot its focus towards growth, moving away from its current dual objective of managing inflation and the labor market simultaneously. He suggests that Kevin Hassett, as the likely next Fed Chair, will champion a reform-focused agenda to align the administration with a pro-growth policy bias.

JP Morgan's Expense Increase and AI Investment

The discussion turns to JP Morgan's stock performance, which declined by over 4% yesterday. This reaction was triggered by comments from CEO Jamie Dimon at the Goldman Sachs Financial Services Conference, where he announced plans to increase expenses to $105 billion next year, exceeding analyst expectations and marking a nearly 10% rise from the current year's $96 billion. Chief Consumer Officer Marianne Lake indicated that the bank is boosting spending on compensation, marketing, and strategic investments, including new branch openings and AI expansion.

Jamie Dimon elaborated on the company's spending on technology and AI. He clarified that the $18 billion figure often cited for technology spending is divided into two parts: approximately $9 billion for "running the bank" (data centers, applications, networks, cyber security) and another $9 billion for future initiatives, including new applications, security protocols, data centers, and cloud infrastructure (both public and private). He detailed efforts to reformat data for machine learning and generative AI, estimating that the company spends "quite a bit of money" on AI, though not quite a billion dollars. Dimon also highlighted the benefits derived from AI, estimating at least $2.5 billion in cost savings through reduced fraud, higher prospecting rates, more efficient marketing, and fewer customer errors, describing it as a "very broad-based thing."

AI Adoption and Market Implications

Darius Dale views the adverse stock reaction to JP Morgan's expense announcement as potentially bullish for the broader stock market in the long term. He argues that this will compel corporate America to accelerate AI adoption as a cost-control measure. This, in turn, is expected to lead to a booming economy with strong corporate profits, which is ultimately very positive for the stock market, even if not ideal for society.

Investment Strategies for the Year Ahead

When asked for investment strategies, Dale suggests that many of the approaches that have been successful are likely to continue working. He anticipates a "white knuckle bull market," characterized by significant gains but also high volatility. Investors are advised to maintain a long-term perspective, recognizing that the economy and corporate profitability are expected to grow faster than consensus estimates, with increased liquidity from the Fed.

However, Dale cautions that the next three to six months could be volatile. This is attributed to the Federal Reserve's concerns about the affordability crisis and "politicized attacks" on the institution. Despite this short-term choppiness, Dale remains optimistic about the long-term outlook, believing the market will ultimately resolve much higher. He reiterates his long-standing advice to buy stocks, stating that they have been recommending this strategy since April.