No aggressive Fed rate cuts unless labor market really deteriorates, says Peter Boockvar

Key Concepts

• Core PCE Inflation: The Personal Consumption Expenditures (PCE) price index, excluding food and energy prices, used by the Federal Reserve to measure inflation.
• Effective Fed Funds Rate: The actual interest rate at which banks lend funds to each other overnight.
• Dot Plot: A chart summarizing individual Fed governors' projections for future interest rate targets.
• Real Rate: The nominal interest rate minus the inflation rate.
• AI Tech Trade: Investment and trading activity focused on companies involved in artificial intelligence and technology.
• Rate Tweaking Cycle: A period of small adjustments to interest rates, as opposed to large, aggressive cuts.

Inflation and Fed Policy

• Current Inflation: The core PCE inflation for August is holding at 2.9% annually, aligning with expectations.
• Fed's Stance: Peter Bookvar believes the Fed still has an inflation problem, limiting its ability to cut rates significantly.
• Real Rate Target: The Fed's dot plot suggests a long-term real rate of 1%. With the effective Fed funds rate at 4.08%, the Fed is close to this target.
• Rate Cut Limitations: Further rate cuts will depend on inflation decelerating or a rise in the unemployment rate, prompting a reassessment of the desired real rate.
• Market vs. Fed Expectations: There's a disconnect between market expectations for rate cuts and what the Fed can realistically do, potentially leading to a market pullback.
• Fed Communication: Multiple Fed members have indicated a meeting-by-meeting approach, suggesting only one or two more rate hikes at most.

Market Dynamics and Potential Pullback

• Stock Market Rally Drivers: The stock market rally has been fueled by the AI tech trade and expectations of Fed rate cuts, particularly benefiting small and mid-cap stocks.
• AI Tech Trade Exhaustion: A potential reason for a market pullback is the AI tech trade exhausting itself, exemplified by Oracle's stock performance after a spike.
• Rate Tweaking vs. Cutting: The current environment is characterized as a "rate tweaking cycle" rather than a full-blown rate-cutting cycle.

Interest Rates and Economic Health

• Real Rate Preference: Peter Bookvar believes interest rates should be above the rate of inflation for a healthier economy.
• Historical Context: Pre-Great Financial Crisis, real rates were typically 2-3%, while some, like Steve Myin, suggest they should be at zero currently.
• Current Real Rate: The current real rate is approximately 1%.
• Bond Market Reaction: There are early signs of the bond market reacting to inflation concerns, similar to last September.

Notable Quotes

• "The biggest problem that lower to middle income consumers have is the cost of living." - Peter Bookvar, highlighting the impact of inflation.
• "...a rate tweaking cycle rather than a rate cutting cycle." - Peter Bookvar, characterizing the current monetary policy environment.

Conclusion

The key takeaway is that while inflation is moderating, it remains a concern for the Fed, limiting the extent of potential rate cuts. Market expectations for aggressive rate cuts may be misaligned with the Fed's likely actions, potentially leading to a market pullback. The AI tech trade, a significant driver of the recent rally, may also be losing steam. A healthy economy, according to Bookvar, requires positive real interest rates, which are currently around 1%.