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It’s Not Over Until It’s Over

APA Jones 3x4HI RGBWith little fanfare, the Federal Reserve cut interest rates another quarter-percent in October. The cut was largely anticipated; more important was the Fed’s forward guidance on the future path of interest rate policy. The latest reduction now makes three consecutive rate cuts in as many meetings. While each quarter-point cut may not mean a lot in the grand scheme of economics, the series of cuts are beginning to have an impact. With some signs surfacing that the economic slowdown is stabilizing, has the Fed now done enough to kickstart the economy? From a historical perspective, three cuts were all that was needed to create an economic resurgence in 1995.

Could This Really Be 1995?

In July I wrote about the possibility that this could be 1995 all over again. In many respects, the very possibility of that was rather wishful thinking. And certainly, in many of my recent commentaries I’ve highlighted that downside economic risk appears higher than the off chance that the economy masterfully navigates the headwinds toward stronger sustainable growth. However, a few months and three Fed rate cuts later, the resemblance to 1995 is a bit more compelling. With inflation running below target, the Federal Reserve had the unique opportunity to cut interest rates to spur growth, just like in 1995. If successful, there could be more gas left in the U.S. economic tank. But how should we define success?

Rate Cuts Could Spur Private Consumption

Lower interest rates could help stimulate private consumption. In fact, positive effects are emerging in the housing market. After over a year of weakening housing data, there are now signs that the weakness could be subsiding. As housing is highly dependent on interest rates, this is an expected outcome; but it also is very welcome news. It confirms that Federal Reserve policy is still effective. As hard as it may be to believe, the effectiveness of Fed policy is more than a fleeting concern in today’s environment. With interest rates near historic lows, there are few tools left in the Fed’s toolbox. The current fire drill could provide invaluable insight into future policy. 

What About Business Investment?

More challenging for the Fed is stimulating business investment. Businesses increase investment when demand increases. Interest rates play a role but are generally not the big driver. If consumers increase spending enough for businesses to anticipate increased demand moving forward, then increasing business investment will come naturally. However, with businesses, the big potential impact of lower interest rates takes time to develop. 

Economic Dashboard Shows Signs of Improvement

The “Alle Award” for most significant improvement on Allegiant’s Economic Dashboard this month goes to the 10-year/3-month treasury spread. (Alle is the name we’ve given Allegiant’s dragon icon.) While the inverted yield curve dominated headlines over the past few months, there has been little acknowledgement of the drastic improvement in the yield curve over the past few weeks. Partially due to the Fed lowering short-term interest rates, but also due to longer-term rates moving higher on the hope for economic improvements, the yield curve has quickly turned from red to green on our Dashboard. This does not mean we are out of the woods. In fact, this could easily revert in the months to come. However, it is further evidence that an imminent recession is in no way a guarantee. 

The economic data shows a slow patch, but that slow patch could turn into a resurgence almost as easily as it could turn into the next recession. At potential inflection points like today, it is very important to follow where the data leads. The Investment Research Team is monitoring economic conditions closely with an eye on helping you along your path to success. As stewards of your capital, your success - however you define it - is our primary objective. Building all-weather portfolios able to withstand the occasional turbulence is one of the ways we help you along your path.

If you would like to see more data and charts about the economy and various financial markets, please click here to view our Monthly Insights book.

Benjamin W. Jones, CFP®, AIF®
President, Chief Investment Officer, Principal

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