At the Money: How To Know When The Fed Will Cut – The Big Picture

At the Money: How To Know When The Fed Will Cut with Jim Bianco (March 13, 2024)

Markets have been waiting for the Federal Reserve to begin cutting rates for over a year. What data should investors be following for insight into when they will begin? Jim Bianco discusses initial unemployment claims data and wage gain to identify when the Fed will start lowering rates.

Full transcript below.

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About this week’s guest: Jim Bianco is President and Macro Strategist at Bianco Research, L.L.C.

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TRANSCRIPT: At the Money: When Will The Fed Cut?

Over the past few years, it seems as if markets have been obsessed with Federal Reserve action. First, the rate hiking cycle, and now, quote unquote, the inevitable rate cuts. Investors might find it useful to know when is the Fed going to start a new cycle of cutting rates.

As it turns out, there’s specific data you should be looking at to know when that cycle might begin.

I’m Barry Ritholtz, and on today’s edition of At The Money, we’re going to discuss how you can tell when the Fed is going to start cutting rates. To help us unpack all of this and what it means for your portfolio, let’s bring in Jim Bianco, Chief Strategist at Bianco Research, and His firm has been providing objective and unconventional research and commentary to portfolio managers since 1990, and it is top rated amongst institutional traders.

So Jim, let’s just start with the basics. How significant are rate cuts or hikes to the typical market cycle? How much do they really matter?

Jim Bianco: Thanks for having me, Barry. And the answer is they matter more now than they have, say, over the last 15 years for a very simple reason. There is a yield again in the bond market.

And as my friend Jim Grant likes to say, who writes the newsletter Grant’s Interest Rate Observer, it’s nice to have an interest rate to observe again. And because of that, we’ve got a whole different dynamic. Well, in 2019, when your average money market fund was yielding zero and your average bond fund was yielding 2%, we used to scream, TINA — there is no alternative. You can’t sit there in a zero money market fund. You got to move up the risk curve to stocks and you’ve got to, you know, try and get some kind of a reward from it.

Well, in 2024, now money market fund is yielding 5. 3 percent and a bond fund is yielding around 4. 8 to 5%. Yeah. Well, that’s two thirds of what you can expect out of the stock market. And especially if we wanted to stick with a money market fund and virtually no market risk, cause it has an NAV of 1 $ every day. And there’s a fair number of people who say 70%, two thirds of the stock market without any risk at all, market risk that is – sign me up for that.

Barry Ritholtz: So let’s talk about raising and lowering rates. I have to go back to 2022  when the Fed began their rate hiking cycle. It seems like a lot of investors were blindsided by what was arguably the most aggressive tightening cycle since Paul Volcker – 525 basis points in about 18 months. Why, given what had happened with CPI inflation spiking, why were investors so blindsided by that?

Jim Bianco: They had gone 40 years without seeing inflation. And they couldn’t believe that inflation was going to return. And the typical economist actually was arguing that there is no more inflation again. And I might add to this day, the typical economist still argues that we don’t have inflation.

Now, I’m fond of saying the term two things could be true at once. And what you saw in 2021 and 2022 is transitory inflation that got us to 9 percent on CPI. But once that transitory element of 9 percent is settled out, what I believe we’re starting to see more and more of is: There is a new underlying higher inflation level. It is not 2%. It is more like 3 or 4 percent inflation. Not, as I like to say, it’s not 8, 10 or Zimbabwe, it’s 3 or 4%. And that 3 or 4% Is what’s got the Fed slow in cutting rates. It’s got people debating whether or not interest rates should come down more or go up more.

So, yes, we had transitory inflation because of the lockdowns and the supply chain constraints. And that has gone away, but left in its wake is a higher level of inflation. And that is the debate that we’re having right now. And if we have a higher level of inflation, that is going to weigh heavily on monetary policy. He hasn’t done them any good.

Barry Ritholtz: So in the mid-90s, where were rates, how high had they gone up? And then how much lower had the Fed taken them?

Jim Bianco: So they were at 6 percent at their peak. In late 1994, and the Fed started to cut rates. And then they eventually wound up cutting them all the way down to 3%. At that point, we thought that 3 percent was a microscopically low interest rate. Little did we know what we were in store for over the next 20 years.

So those rates were not very different than the rates that we’re seeing today, with the Fed being at 5, 5.25 and with the bond, with the yield and the 10 year treasury at around 4.15 to 4.20. So we’re kind of in the same range that we’ve seen then.

Barry Ritholtz:  So if I’m an investor and I want to know the best data series to track and the levels to pay attention to that are gonna give me a heads up that, hey, the Fed is really gonna start cutting rates now. What should I be looking at and what are the levels that suggest, okay, now the Fed is going to be comfortable, maybe not cutting them in half the way they did in the mid 90s, but certainly taking rates from 5,, 5.25 down to 4, 4.2. 4.50, something like that.

Jim Bianco: So one forward-looking measure and one kind of backward-looking measure that matters for the Fed:

The forward-looking measure is going to be probably the labor market. What the Fed is most concerned about is higher interest rates, are they going to weigh on business borrowing costs? and reduce their propensity or willingness to continue to hire workers.

So let’s look at the Initial Claims for Unemployment Insurance. It’s a number that’s put out every Thursday for the previous week. Initial claims, everybody has unemployment insurance. It’s a state program. The Bureau of Labor Statistics just aggregates the 50 states and puts out that number on a seasonally adjusted basis.

It’s in the low 200, 000s right now. That is, over the last 50 years, an extraordinarily low number.  And so if it goes up to 225k or 240k, it’s still a low number. I think if you start seeing it, you know, start pushing 275 or above 300, 000 are in, that means new recipients for unemployment insurance that week.

Then I start thinking that, there is a real problem starting to brew in the labor market. The Fed will see that too And the propensity for them to cut will grow and I want to emphasize here 200,000 Wall Street tends to kind of get themselves myopic here – “Oh, it went from 200,000 to 225,000 230,000 the labor market is weakening.”  No, that’s all noise down near the lowest numbers that we’ve ever seen in 50 years It’s got to do something more significant than that.

Barry Ritholtz: What’s the best inflation data to track that you know Jerome Powell is paying attention to?

Jim Bianco: So, Powell likes this obtuse number, and he likes it because he made it up, called, SuperCORE. So, it’s, inflation less food, less energy, and less housing services. Now, before you roll your eyes and go, So you’re talking about inflation, provided I don’t eat, I don’t drive, and I don’t live anywhere.

Barry Ritholtz: Inflation, ex-inflation, right? Right.

Jim Bianco: What’s left over is driven by wages. And why he looks at that is he’s trying to say, Are we seeing a wage spiral? Now, why is a wage spiral important? No one is against anybody getting a raise. But the fact is, if everybody’s getting a 4 percent raise, you can afford 3 to 4 percent inflation.

If everybody’s getting a 5 percent raise, you can afford 4 percent inflation. 4 percent inflation and that’s what they’re most concerned about is getting that inflation spiral going with a wage spiral. So they look at the super core number as a way to say, yes, we understand that there’s housing. We understand that there’s driving. We understand that there’s eating and there’s inflation in those three.

We also understand that there’s weight inflation. And that’s what they’re trying to do, is look at wages. And so that’s probably the best measure to look at.

Barry Ritholtz: So, I know what a data wonk and a market historian you are, but I, I suspect a lot of investors, a lot of listeners, may not know what happens to the bond market and the equity market once the Fed finally begins cutting rates.

Jim Bianco: It depends on why because there are two scenarios in there.

If the Fed starts cutting rates, like it did in 2020, or like it did in 2008, or like it did even in 2001, and it’s a panic. “Oh my god, the economy’s falling apart, people are losing their jobs, we’ve got to start to stimulate the economy, we have to stop a recession.”

If they’re cutting rates because of a panic, it doesn’t work. We involved, we had recessions every time they started doing that last one being 2020, uh, when they saw what was happening with COVID. And, and because it is projecting a recession, which means less economic activity, lower earnings, it’s usually a difficult period for risk markets like the stock market or real estate prices and the like.

If the Fed is cutting rates. Like they did in 1995 or like they did in  2019, it’s kind of a victory lap. “We did it! We stopped the bad stuff from happening. Our magic tool of interest rates accomplished everything that we need. Now we don’t need a restrictive rate anymore.”

And they back off of that restrictive rate. Well, in 1995 and 2019, risk markets took off. Now, 2019 was short-lived because then COVID got in the way. And that was an exogenous event that was not financially related. But they were going right up until the moment that COVID hit.

So why is the Fed cutting rates? It really matters more than when will they cut rates. And right now, what everybody’s hoping for is the why will be a victory lap. “We did it. We stopped that bad old inflation. It’s gotten back to our 2 percent target. We could go back to the way we were pre-pandemic.”

And then once we’re there, we can now start to back off of this restrictive rate, and everybody will celebrate that, yay, we’re getting interest rate relief without it being a signal that the economy is falling.

Barry Ritholtz: So to wrap up, investors hoping for rate cuts should be aware that sometimes there’s a positive response when it’s a victory lap. Sometimes when it’s revealing, uh, the economy is softening or a recession is coming,  tends not to be good for stocks. Volatility tends to increase.

It’s a classic case of be careful what you wish for. But if you want to know what the Fed is going to do. You should keep track of initial unemployment claims when they get up towards 300, 000 per week. That’s a warning sign. And follow Chairman Powell’s super core inflation where he looks at the rate of wage increases to determine when the Fed begins its newest rate-cutting cycle.

I’m Barry Ritholtz, and you’ve been listening to Bloomberg’s At The Money.

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