Stocks and Bonds Rally on Potential Lower Rates

Stocks and bonds and gold all rallied on Friday after Federal Reserve Chairman Jerome Powell, in statement at the annual Jackson Hole Conference, opened the door for an interest rate cut at the September Federal Reserve meeting. The move in stocks, with the S&P 500 up more than 1.5% reflected how closely the market is watching the Federal Reserve.

Indeed, all eyes appear to be on Jerome Powell who is under considerable pressure from President Trump to lower interest rates sooner rather than later.  The market fully expects at least a 0.25% reduction in the Fed Funds rate by December. The bigger question is whether the reduction will happen in September or later in the year. Powell’s comments increased the chances of a September cut, driving the rally in stocks. On Thursday, before Powells statement, the odds of a September interest rate cut at Polymarkets was 61%. However, by Friday market close the odds of a September interest rate cut had risen to 77%.

Perhaps even more significant in the long term, the Fed has adopted a new policy framework that deleted, “the Committee seeks to achieve inflation that averages 2% over time” and replaced it with the language, “The Committee reaffirms its judgement that inflation at the rate of 2 percent…is most consistent over the longer run with the Federal Reserve’s statutory maximum employment and price stability mandates.” With this slight change in language Powell seems to be signaling willingness to accept slightly higher inflation. Rather than seeking to achieve 2% they reaffirm their judgement that 2% is most consistent with their mandates in the long-term.

Of course, the final decision on the rate cut will not happen until the Federal Reserve meeting September 16-17.  Until then the market will continue to watch the economic data, inflation and labor market indicators in particular. A weak labor market could give the Fed more reasons to cut interest rates, and somewhat counter-intuitively, be good news for stocks. Conversely, hot inflation data could cause the Fed to pause any rate cuts and result in a market pullback.

As we have explained in the past, lower interest rates are stimulative to the economy because lower rates lower the cost of debt-based investing and spending. Higher interest rates act as brakes to the economy, increasing the cost of borrowing and curbing investment. Lower interest rates at the September Federal Reserve meeting could further stimulate the economy and economic growth.