First off, I don't like flying...I try to avoid it if I can. Something about the inability to be in control at 30,000 ft. above the ground in a cylindrical metal tube gives me the sweats! Nonetheless, as we discuss the current and projected U.S. economy, it seems that there are many who have similar feelings of anxiety with the market as I do with flying.
The Fed, as pilot of the U.S. economy, began its initial descent with a 50-basis point (bp) rate cut at its September meeting, which was the first in over four years. As we prepare for landing, key questions remain for market participants: how long and how fast will the descent be (pace of rate cuts and terminal Fed Funds rate), and how smooth will the landing be (recession or mild slowdown)?
Equity prices and indices are near record highs, credit spreads are tight, and access to credit remains strong. Volatility measures are historically low, and Fed funds futures suggest steady cuts through 2025, ending between 3.00% and 3.25%. This represents a “soft landing” scenario, where the market is already applauding the Fed before touchdown.
As passengers on this proverbial plane, we hope the market is correct.
However, there are still some headwinds to consider. If we were to consider that this post-pandemic cycle mirrors past cycles, where higher financing costs slow consumption and investment, reducing demand for goods and services, and triggering rising unemployment. This negative dynamic, where weakened consumption leads to lower demand for labor, drives up unemployment further, leading to an eventual recession.
Increases in consumer auto loan and credit card delinquencies, slowing retail sales, and price cuts from major retailers are early indicators that the economy’s momentum is already faltering despite modest rate cuts. Furthermore, a more aggressive rate-cutting cycle and lower terminal rate would result in lower equity prices and wider credit spreads.
We do anticipate more turbulence this quarter while still being cautiously optimistic about the Fed's path to a soft landing. We continue our strategy with a focus on equities with strong fundamentals and high-quality debt positions in our diversified portfolios as we look to weather the potential storms ahead.
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