Markets are wrong about a rate cut rally

This week’s economic calendar, particularly the release of the core Personal Consumption Expenditures (PCE) price index data, had a significant influence on market sentiment. The July data revealed a 0.2% increase, in line with expectations, which bolstered the belief that inflation is under control. This positive development uplifted investor sentiment and fueled optimism about the Federal Reserve maintaining a steady monetary policy.

Additionally, U.S. consumers continue to show resilience. In July, personal incomes rose by 0.3%, surpassing expectations, while personal spending increased by 0.5%. This suggests that consumer spending remains robust despite potential economic challenges. Furthermore, the Commerce Department revised its estimate of second-quarter GDP growth upward, largely driven by stronger consumer spending.

However, challenges persist, particularly in the housing sector. Pending home sales in July plummeted to their lowest level in over two decades. The National Association of Realtors attributes this decline to affordability issues and uncertainties surrounding the upcoming presidential election. Rising interest rates and limited housing inventory have made homeownership increasingly difficult for many potential buyers. The Consumer Price Index (CPI) came in at 2.6% year-over-year, slightly better than the expected 2.7%, leading to speculation about potential market upside if next week’s unemployment data exceeds expectations. Despite this, the markets are mistaken about a forthcoming rate cut rally.

In the very short term, markets might rally, but ultimately, a 25 basis point cut isn’t enough. The labor market is weakening, despite Panteon Macro’s expectation of a potential dip in the unemployment rate in September’s data, which could negate recessionary warnings tied to the Sahm rule. However, I disagree. The labor market is in worse shape than it seems. Many large tech and manufacturing firms are beginning to—or have already—initiated mass layoffs. For example, Goldman Sachs recently announced plans to lay off 1,300 employees, while Klarna hinted that it could replace 50% of its workforce with AI.

This suggests that any recession driven by labor will stem from white-collar job losses rather than blue-collar. Higher-income individuals might be less likely to claim unemployment benefits for various reasons, such as receiving severance packages, having higher savings, or facing stigma associated with unemployment, among others. As a result, labor and employment data might be lagging and severely inaccurate. I believe this is the case, but it won’t last forever—people will eventually deplete their savings. Just last quarter, the savings rate dropped to 3.3%, even amid higher living costs, rising mortgage rates, and increasing per capita debt.

One concern is that people typically don’t start aggressively saving until they sense an impending recession, but by then, it’s often too late, and they’re already in one. I believe we are either on the cusp of or already in a recession, which explains why Warren Buffett, the king of trading, is sitting on hundreds of millions in cash and has sold stakes in Bank of America, Apple, and others.