The Last Inflation Report Before a Rate Cut Decision

Week in Review

The stock market has shifted its focus from the expectation of further Fed rate cuts to concerns about a growth scare in the economy. While the upcoming rate cuts from the Fed are being priced into markets, investors are now turning their attention to the next set of worries that come with every economic cycle.

The latest jobs report, although indicating a healthy labor market, also points to a slowdown. The economy added 142,000 new jobs in August, with the July growth being revised down to 89,000 from the previously reported 114,000. On the positive side, this gives the Fed the green light to proceed with a rate cut at their upcoming meeting, as inflation appears to be under control.

Currently the market expects about 1% in rate cuts by year end. What is more important is that rates are expected to be cut by about 2% over the cutting cycle, the debate in 2025 will be the pace of those cuts.

The manufacturing sector, in particular, showed weakness with a loss of 24,000 jobs, compared to the expected loss of 2,000. This is consistent with the recent ISM Manufacturing survey data, which also indicated a continued contraction in the U.S. manufacturing sector.

On the other hand, the services economy saw the largest job gains in sectors such as leisure and hospitality, education and health services, and government, although the growth in these areas was lower than last year's levels. This suggests that even the peak job growth in the services sectors may be behind us.

Despite these concerning trends, there were some silver linings in the report. For instance, the unemployment rate did decrease from 4.3% to 4.2%, although it remains above last year's low of 3.4%. It is also well below the long-term average of 5.7%. Additionally, the rise in the unemployment rate can be attributed to new entrants into the workforce, rather than an increase in job losses.

The market is currently anticipating a potential interest rate cut of either a quarter-point or half-point at the upcoming September meeting on the 18th, with a 30% probability assigned to the latter. While a half-point cut could boost growth assets, it would also indicate the Fed's concern about the state of the economy.

Investors were already feeling uneasy due to weak economic data and cautious remarks from central bankers, resulting in the worst week for US stocks in over a year. Fed officials, including governor Christopher Waller and New York Fed president John Williams, have expressed support for multiple rate cuts this year in response to declining inflation and a softening labor market. This sentiment contributed to the S&P 500's 1.7% drop on Friday and a 4.2% decline for the week, marking its most significant weekly loss since March 2023. The tech-heavy Nasdaq Composite also took a hit, experiencing its largest weekly decline since January 2022.

Despite this recent downturn, the market has seen substantial growth so far this year, with the S&P 500 increasing by approximately 18% through the end of August. However, with September and October historically being volatile months for the market and the impending US elections, a correction of 5% to 10% or more could occur in the coming weeks. Nevertheless, the fundamentals suggest that the market will continue to expand, with inflation moderating, the Fed poised to cut rates, and economic growth still holding steady.

For long-term investors, it may be wise to take advantage of market dips by rebalancing portfolios, diversifying, or adding high-quality investments at potentially lower prices. Additionally, lower interest rates can benefit both consumers and corporations in terms of borrowing costs, potentially leading to an eventual re-acceleration of economic growth.

Our recommendation is to take a closer look at large-cap and mid-cap US stocks and consider diversifying beyond the mega-cap technology sector.

For those who are heavily invested in short-term cash instruments such as CDs or money-market funds, it is important to be mindful of reinvestment risk as interest rates are expected to decline further. Gradually extending the duration of investments in high-grade bonds (long term bonds) may be a suitable alternative, especially considering the likelihood of future Fed rate cuts in 2024 and beyond.

Economic & Earnings Calendar

The highlight of the week will be the inflation data for August, which will be the last major economic release before the highly anticipated Federal Reserve meeting in September. All eyes will be on this report as it will likely influence the Fed's decision on a possible interest rate cut.

In addition to the inflation data, there will be several important earnings reports throughout the week, including Oracle on Monday, GameStop on Tuesday, and Adobe and Kroger on Thursday. These reports will provide valuable insights into the performance of these companies and the overall health of the market.

Adobe, a name held widely by our clients, is expected the move over 8% when it reports Thursday evening.

On Wednesday, the Bureau of Labor Statistics will release the consumer price index for August. Economists are predicting a 2.6% increase from the previous year, slightly above the Fed's target of 2% annual inflation. Thursday will see the release of producer price data, which will also be closely monitored by investors.

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Disclaimer: The author of this blog is a financial advisor but may not be the right advisor for you. In fact, the author may not even be the right advisor for themselves. Please consult a qualified professional before making any financial decisions based on the content of this blog. And remember, just because the author has a fancy title and a briefcase full of spreadsheets, doesn't mean they know what they're doing.