Stop debating over when the Fed will cut rates, how big the first rate cut will be, or how many rate cuts will happen this year.
You’re wasting your time.
Rate cuts are here, and they’re already giving the economy a boost.
Financial conditions – or the difficulty of borrowing and investing money – are back to where they were before rate hikes started in 2022. That’s led to stronger confidence, higher market prices, and the sense that normal may finally be within reach.
The deep freeze
We’re about a month past the Fed’s last meeting, and it feels like the winter is thawing.
Not literally, of course. It’s 17 degrees Fahrenheit in Charlotte and I’m freezing, just like many of you are.
I’m talking about a winter thaw in two industries – housing and manufacturing – that have been in their worst deep freezes since the global financial crisis.
Last year, existing home sales were the lowest since 2008 as 30-year mortgage rates rose to 8%. Manufacturing activity has contracted for 14 straight months, another streak we haven’t seen since 2008. Americans and companies just stopped buying stuff – cars, dishwashers, houses, bulldozers, machines.
It makes sense, too. When rates are high, people are more discerning with their money, especially when it comes to borrowing. This time around, rates didn’t just rise – they skyrocketed. And in response, the rate-sensitive parts of the economy seized up.
Then in late October, rate cuts happened…but not in the way you’d expect. The Fed’s policy rate stayed steady, yet Treasury yields came down drastically.
The thaw
The 10-year yield dropped a full percentage point over two months, dragging 30-year mortgage rates from 8% to just below 7%. The 2-year yield slid about 80 basis points.
And suddenly, the data picked up. Consumer confidence jumped the most in two years. Mortgage applications picked up at the fastest pace in nine months (on a four-week average basis). Inflation expectations dropped to three-year lows. Building permits and housing starts both grew at the fastest year-over-year pace since early 2022.
The market essentially manifested rate cuts, even though the Fed hasn’t done anything yet.
Lower yields can make a difference. Yields impact pricing on a wide swath of corporate and consumer loans – mortgages, auto, and commercial real estate debt. Suddenly, homes and cars are a little more affordable than they were a few months ago. People notice those types of things.
It’s not unusual to see markets manifest rate cuts like they have lately. In fact, it’s happened consistently before the Fed’s last few rate cycles. Since 1990, the two-year yield has started falling at least six months before the Fed has actually cut rates, releasing some pressure on the economy before policymakers have to.
People have also become extra sensitive to changes in rates after such a fierce series of hikes. A small change can lead to big relief.
The thaw hasn’t reached much of the manufacturing sector yet. New orders – a leading indicator for manufacturing – seem to be stabilizing, and the promise of materially lower rates could encourage businesses to start spending again.
Still, the economy is coming alive without a single edict from the Fed. Don’t overlook how important this is.
A real estate and manufacturing boom could be brewing.
So what does this mean for me?
Stop playing the game. The market’s favorite game these days is to guess how many rate cuts will happen this year. However, don’t let the game distract you. Rates are already coming down, and the number of cuts – while important – holds less meaning for you than Wall Street forecasters and bond quants.
Stay nimble. To be fair, falling yields aren’t always a good signal. Lower yields mean people could be bracing for something ominous in the future. High inflation isn’t completely out of traders’ minds yet, even though the worst may be behind us. Stay nimble and hedged.
Think cyclical. In this instance, it’s important to understand how drastically lower yields impact your investing stance. The economy’s strength continues to surprise everyone, and now the floodgates have opened. It may be worth looking for cheap stocks in economically sensitive sectors.
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*Data sourced through Bloomberg. Can be made available upon request.