The Holy Grail

July 29, 2024

This week, as the Fed's interest rate setting committee convenes, they face another opportunity to achieve the elusive 'holy grail' of monetary policy: soft-landing the economy. Balancing between an economy that's neither too hot (inflationary) nor too cold (high unemployment) has long been a challenge.

Inflation is finally cooling, consistent with the latest reading on Personal Consumption Expenditures (PCE). ¹

Monthly PCE, excluding shelter (a measure I consider flawed), is also showing a slower pace of increase. It's worth noting that year-over-year comparisons may become more challenging, as the October-December 2023 period saw relatively mild inflation. ²

The unemployment rate has risen at a fairly fast pace, according to the BLS. In fact, a 0.4% increase is a historically fast pace. Interestingly, there is an indicator that suggests that a recession typically follows when the unemployment rate climbs 0.5% above its previous low. Currently, this would mean a rise to 4.2% and we will certainly learn more later this week from the July jobs report. ³

Conditions are perfect for the Fed to attempt achieving the holy grail.

Equity returns tend to be strong on average during the full rate cut cycle. ⁴

However, when you unpack each of those rate cut cycles you can see various maximum drawdowns. Interestingly, each of these rate cut periods was preceded by distinct macroeconomic factors. ⁵

1970-1971: Unemployment was high, inflation was moderate. The Fed cut rates to fight off a recession.
1973-1974: Oil embargo threw us into stagflation. Soft landing? Forget about it!
1980-1982: Volcker hiked rates like crazy to crush inflation, but it led to a brutal recession.
1987: Black Monday crash. The Fed stepped in to save the day and keep the economy from tanking.
2000-2002: Dot-com bust and 9/11 hit hard. The Fed slashed rates, but the economy still struggled.
2007-2009: Financial crisis, Great Recession. Massive rate cuts were the only option.
2019-2020: Pre-pandemic, the Fed aimed for a soft landing, but COVID-19 had other plans.

The Fed has never, at least in the last 50 years, had a chance to attempt to achieve the holy grail of monetary policy. Market expectations suggest that the Fed will kick off their attempt in September with a series of rate cuts. ⁶

The grail quest was elusive for Sir Galahad and his knights. Let's see if it will be the same for Sir Powell and his global economists.

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Tim Phillips, CEO, Phillips & Company

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