Aggressive Rate Cuts by the Fed would be Irresponsible

Aggressive Rate Cuts Would Only Produce a Bigger Bubble....That Would Create a Crisis When the Bubble Inevitably Bursts

• The meetings in Washinton DC and Jackson Hole this week might (repeat, MIGHT) produce some big swings in the markets this week. So, we doubt that we’ll see much of the “dog days of summer” between now and Labor Day.

• We believe that it would be irresponsible for the Fed to cut rates in aggressive manner going forward. That would only make the bubble a bigger one than it already is right now. That would create much more serious problems when that bubble inevitably bursts.

The futures are trading slightly lower this morning after the meeting between President Trump and Russian President Putin did not produce anything concrete towards a ceasefire in the war between Russia and Ukraine. The expectations had been set very low by the Administration, so the lack of progress towards their goals was not a big surprise (and thus the move is not very large this morning). However, after so many victories for the Administration in recent months, there were some expectations of a positive surprise from the Alaska Summit.

Today, Ukrainian President Zelenskiy will meet with President Trump in the White House…and several European leaders will be coming to Washington as well. So, we’ll see if this creates anything positive (or negative) for the markets……..This war has not had much of an impact on the markets over the past three years, so we don’t know if it will create any tailwind or headwinds over the near-term…..However if, for some reason, the situation deteriorates over time, it could certainly have an eventual impact.

The other big meeting this week will be in Jackson Hole, Wyoming…where the Kansas City Fed’s annual symposium begins on Thursday. The expectations for a rate cut in September have been well-established by the “Fed speak” of the past several weeks. So, it does not seem like Chairman Powell’s comments this week will have an outsized impact on the markets…especially since the odds of a 50-bps cut have faded considerably. That said, if he DOES put at bigger than 25-bps cut on the table…or if he speaks in a much more hawkish tone (and thus lower the odds of any rate cut in September)…that could obviously change things very quickly and create a big move in the markets one way or the other…....Put another way, no matter how low the expectations might be for a big reaction to the Chairman’s comments, we’ll all still be listening very closely to what he has to say.

We spent a decent amount of time in our weekend piece…discussing the absurdity of the thought of cutting interest rates in an aggressive manner when the stock market…and other markets…are in a bubble. Creating an even bigger bubble might be great for investors over the short-term, but it will only generate a very large problem (crisis) down the road. We believe the Fed knows this…and will act accordingly.

We read this morning that even OpenAI’s Sam Altman is reportedly saying that the AI industry is forming a bubble. (Our response to that is: Duh…of course it’s in a bubble.) However, there are plenty of others who disagree. Therefore, if the Fed begins cutting in an aggressive fashion…it will only raise the already elevated animal spirits for investors. That, in turn, will only create a bigger bubble…and when that inevitably bursts, it will be disastrous for markets…AND the economy. Thus, we believe that the odds that the Fed will aggressively cut interest rates…before the economy shows serious signs of weakness (and before the stock market has fallen in a significant way) are extremely low.

We must admit, the fact that nobody besides ourselves is talking about this subject is mind boggling. In our opinion, it would actually be irresponsible if the Fed started cutting rates in a dramatic way…because inflating an even bigger bubble…at a time when total debt in the US is astronomical…would risk an eventual crisis which would be extremely difficult to recover from in the future.

This goes back to an assertion we have made many, many times over the years: Not only is the Fed “data dependent”…but they are also quite “market dependent” when it comes to implementing their policies. In this case, acting in the way that the uber-doves would like…would only raise the odds of a major disaster in the future…even if it helped things over the shorter-term. Therefore, we believe that Chairman Powell and the Fed will refrain from acting in an overly aggressive manner when cutting rates…and we also believe that it will be the correct policy to follow.

Yes, we realize that by not reacting in an aggressively dovish fashion, the Fed will risk a further slowdown in growth. They will also risk allowing the US economy to fall into a recession. However, those risks pale in comparison to what will happen if they inflate today’s bubble into an even bigger one.

Instead, we believe that they will do what they have done in the past. They’ll let the economy and the markets do what they’re going to do on their own (move in a natural fashion)…and then step-in to provide a safety-net AFTER a lot of speculation and froth have been wrung out of the markets.

This does not mean that the Fed will not cut at all this year. Mild rate cuts take a long time to filter through the economy…and thus they’re less likely to create a big increase in speculation (or a further rise in animal spirits) going forward. However, we do believe that the extremely high valuation level of the stock market…and the enormous jump in speculation in recent months…is something that the Fed will consider (very seriously) as the decide how they’re going to act over the coming months……Yes, they will get a lot of blame if/when the economy slows further and the stock market declines. However, since the alternative would likely lead to an even bigger bubble…and an eventual crisis…it will be the correct strategy to follow going forward.