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Bear Comes First When Rate Cut: Perspective on the 2024 US Economic Performance

Updated: Apr 24

Apri-22,2024:

Greetings, I am Aaron. In this article, I aim to share my perspectives on the U.S. Economy and the S&P 500 with you. Firstly, I’ll delve into the performance of the U.S. real GDP. Secondly, we shall explore the sentiments prevailing among individuals yearning for interest rate cut by the Fed and why it is crucial to approach this situation with caution. Thirdly, we will examine the sentiment within U.S. businesses by looking at reports from NFIB and evaluating the employment scenario. I will conclude with my biased suggestion on the US Economy.      


Firstly, let us commence by analyzing Real GDP's performance - Q4 of 2023 witnessed an impressive growth rate of 3.4%, while forecasts predict a respectable figure of 2.2% for Q1 of 2024; aligning well with S&P 500's commendable YTD increase of approximately 5% as of April 22nd, 2024.

However, it is imperative to raise concerns regarding Q3 of 2023 when Real GDP reached a year-on-year high at 4.9%, surpassing that of Q4.


The order of Real GDP releases for the last three quarters, which are Q3 2023, Q4 2023 and Q1 2024, is as follows: 4.9%, 3.4%, and 2.2% (forecast) respectively. I have observed a consistent decline over the past two quarters (including the estimated figure for Q1,2024 if this is true). The initial inquiry should focus on understanding the reasons behind the decrease in the last quarter of 2023 and why the forecast for Q1 2024 remains at an even lower level while the S&P 500 has created an all-time high milestone. But we do see the S&P 500 is heading down from all time high in terms of YoY% basis.



Secondly, the Fed’s objective is to bring down the persistent CPI (which was mainly caused by massive fiscal stimulus and aggressive interest rate cuts aimed at rescuing the U.S. economy during the pandemic) in order to reach its target level of 2%. However, since last year, we witnessed the CPI has been consistently moving sideways. In fact, the All Items CPI, even has slightly increased to 3.5 % in March from 3.2% in February. The behaviour of CPI has made US central bankers feel like there’s “no urgency” to cut interest rates.



The only person in the Fed that is on Dovish bias is Patric Harker, Philadelphia Fed President: When it comes to a rate cut, I think we are close, give us a couple of meetings” Feb 22, 2024


More bankers are on Centrist bias, such as John Williams, NY Fed President: Three rate cuts in 2024 is "a reasonable kind of starting point." (Feb 28, 2024) "I definitely don't feel urgency to cut interest rates." April 18, 2024


Jerome Powell, Fed Chair: "Right now, given the strength of the labour market and progress on inflation so far, it's appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us." April 16, 2024


What would happen if the Fed decided to start cutting interest rates in 2024 or 2025? Based on what I've observed about the Fed Fund Effective Rate, my perspective on how the reduction of interest rates affects the stock market is pessimistic. After each rate hike pause, we typically observe a few quarters of robust GDP growth followed by a recession, with the exception of 1995's soft landing when no recession ensued.

For instance, in March 1989, the FFER reached its peak and the highest real GDP growth that year was 3.1% in Q2, followed by a recession starting in Q4.


Similarly, in October 2000, the FFER peaked in Q4 and we observed another peak of 2.4% real GDP growth for the same quarter released next year before entering a recession in Q1, 2001.


In May 2007, the FFER again reached its peak during Q2 with a subsequent strong performance of 2.5% real GDP growth in Q3; however, a recession began in Q4 of that year.


Lastly, April 2019 saw another peak for the FFER before experiencing a remarkable growth rate of 4.6% real GDP during Q3; unfortunately, this was followed by a recession starting from Q1,2020.



To me, this is a classic case of "be careful what you wish for." The streets are anticipating an interest rate cut from the Fed, thinking it will create an easy environment without realizing that the bear comes before the bull when rates drop.


The following chart shows the S&P 500 tends to peak when the Fed is about the cut rate:


I watched a YouTube video where people discussed the U.S. economy's low sensitivity to changes in interest rates, prompting me to review data from FRED and NFIB. The data confirms that high interest rates increase financial pressure on U.S. households, leading us to infer that consumers are reluctant to spend due to the high interest rate environment (also with the inflationary one), prioritizing expense reduction over household spending.



On the business side, from the NFIB’s report, its component, the "Relative Interest Rate Paid by Regular Borrowers" tells us that businesses are facing tightened financial conditions where they have paid higher interest on their loans relative to the prevailing market rates. This metric is part of the NFIB's monthly surveys, which assess various aspects of small business operations, including credit conditions. Surprisingly, this indicator also has a good track record of predicting each recession except the case in the mid-90s. The peak indicator suggests that businesses are facing higher interest costs, and for those looking to cut expenses, layoffs are likely the first consideration - an easy and straightforward approach to meet this need.

The solid indicator from NFIB suggests that the theory of "less interest rate sensitivity" is not applicable, as small businesses in the U.S. are indeed facing tight financial conditions and paying high interest caused by the Fed.


Therefore, we also want to examine the employment situation as inflation appears to be heading towards its 2% target level. However, the employment situation indicates that things have changed. Let's start by analyzing the changes in the fed fund effective rate and how it has influenced the movement of the unemployment rate. I have observed that FFER changes typically precede a change in the unemployment rate by 2 years. This leads me to wonder if this is the time when we will see an increase in the unemployment rate following an upward trend in FFER, possibly occurring in 2024 or 2025.



The increase in part-time workers and the decrease in full-time workers indicates an initial weakening of the labour market.



The responses from NFIB's survey indicate a growing pessimism among US businesses regarding future employment prospects, with decreasing the “plans to increase employment”. Each time the indicator peaked and then turned downward, it signalled an impending recession. The question raised by this chart is whether the next UR will follow the inverted "Plans to increase employment" and move upward in approximately the next 6 months.



Finally, the Fed is facing a dilemma: they have raised interest rates to 5.3% in order to reach their 2% inflation target, but this has led to tighter financial conditions for businesses and individuals. As a result, businesses are becoming more cautious with expenses and even considering layoffs. Many are calling for the Fed to cut interest rates, but CPI remains stagnant at around 3.3-3.5%, due in part to conflicts in the Middle East (such as between Israel, Iran, and Palestine) and ongoing war between Ukraine and Russia. The Global Supply Chain Pressure Index has a stronger correlation with CPI YoY% when advanced by 9 months. There is a risk of CPI increasing again due to ongoing global issues such as wars, the Chinese real estate problem and its potential recession, Europe's economy nearing recession, and Japan facing similar challenges.



Under such circumstances, if CPI remains above 3% or even increases further, should the Fed continue raising interest rates to bring it down to its 2% goal, despite the potential negative impact on domestic financial conditions and a possible rise in unemployment?


The increasing interest rate is likely to cause higher unemployment, possibly because businesses choose to lay off employees to reduce expenses during tight financial conditions. The rise in part-time workers and decline in full-time workers indicate a weakening labour market. As consumption accounts for approximately 68% of the U.S. GDP, higher unemployment leads to lower purchasing power and eventually an impending recession.


My bias for the U.S. Economy is conservative, so I suggest maintaining a neutral level of portfolio beta. Overweight the Defensives sector and underweight the cyclicals. If we observe the VIX catching up with a 10-2 inverted yield curve, there is a higher probability of witnessing a tumble in the S&P 500.



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