Perspective: Morning Commentary for December 19

Perspective: Morning Commentary

Arlan Suderman

Chief Commodities Economist

December 19 – The Fed has spoken. The Federal Reserve followed through with market expectations of a “hawkish rate cut,” but Wall Street didn’t like it. Stocks fell sharply following the announcement, focused on the disappointment that it won’t get aggressive rate cuts again next year. However, stock futures bounced overnight when traders started focusing on the positive side of the Fed’s statement that focused on a healthy economy. In fact, data released this morning revised third quarter gross domestic product up to an annualized rate of 3.1%. Treasury yields exploded higher following the policy release, driving 10-year yields to six-month highs, which helped drive the dollar index to two-year highs with a steepening yield curve reflecting problems created by mounting government debt. Stock futures are higher this morning, with the VIX trading near 21, after spiking above 28 yesterday. The dollar index is consolidating near 108.0. Yields on 10-year Treasuries are trading near 4.54%, while yields on 2-year Treasuries are trading near 4.31%. Crude oil prices are mixed to higher, while grain and oilseed prices traded mixed to weaker overnight, with wheat prices plummeting on the strong dollar.

First time claims for unemployment benefits fell to 220K in the week ending December 14, down from 242K the previous week, and down from analyst expectations of 230K. The four-week moving average firmed to 225.5K claims, up slightly from 224.25K the previous week. Continuing claims for the week ending December 7 fell by 5K to 1.874 million. The four-week moving average for continuing claims dropped by 6K to 1.880 million.

The Federal Reserve effectively prepared the market for its next action, and then followed through on those expectations yesterday afternoon. And yet, Wall Street acted as if it had been totally caught by surprise by this “hawkish rate cut.” The Fed cut its benchmark interest rate by 25 basis points, while reducing its reverse repo rate by 30 basis points as it tries to wind down that facility’s use. The Cleveland Fed president was the single dissenting vote – desiring to leave rates unchanged. The language of the Fed statement held very few changes from the November meeting. It was interesting to me that it again stated that risks to inflation and employment goals are roughly in balance. That took me back a few months to August. The jobs report released in early August for July put the unemployment rate at 4.253%. The headline consumer price index at that time stood at 2.9%, with the core CPI at 3.2%. Later that month, Fed Chair Jerome Powell stated at the Jackson Hole Economic symposium that inflation was safely heading towards its 2% mandate, and that the central bank was now focused on not allowing the unemployment rate to further deteriorate, raising concerns about the jobs sector in his comments.

Today, the unemployment rate sits at 4.246% and the above inflation readings are at 2.7% and 3.3% respectively. None of those numbers have changed much, yet suddenly everything is doing well, and the risks are in good balance. Powell opened yesterday’s press conference by saying that the labor market remains solid and that inflation is much closer to the 2% mandate. Consider those comments in light of how close current numbers are to his statements in August. The Fed projects two more rate cuts in each of the next two calendar years following the 100 basis points of decline that we’ve seen since September. The Fed projects core inflation to decline to 2.8% in the year ahead, with PCE and core inflation down to 2.0% in 2027. That’s six years above the mandate level IF its projections verify. Of course, one of the big unknowns is tied to the ability of the Trump Administration to cut government spending, that currently provides stimulus for the economy. It’s generally easy to win political support for doing such until the voters actually see what it will cost them in lost benefits. Powell confirmed that his staff studied potential implications of policies supported by the Trump Administration, but everything is on hold until they see what is actually successfully implemented. My question then is, why project additional cuts until that point?

Here's the bottom line. Fiscal stimulus is still upon us. Just take a look at the proposed continuing resolution to fund the government currently being considered in Washington. It was filled with special interest programs needed to get the votes needed to achieve passage by Friday night. That’s stimulative, although it still lacks the votes needed to pass. The wealth effect is also stimulating the economy. Consumers are in a spending mood when they see record highs on Wall Street. Furthermore, their homes have gained a tremendous amount of equity in recent years, leading to a rise in home equity loan applications to fuel additional consumer spending. Wage growth is strong, retail sales are strong, consumer confidence is rising, and the economy is solid. Consumers just voted for a president who promised more tax cuts and deregulation, which is also stimulative. I could make an argument that interest rates are already below neutral in this environment, which means that yesterday’s rate cut is also stimulative. This does not guarantee a return of inflation in 2025, but it does increase the risks of such. Historically, that’s been supportive for the broader commodity sector.

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