In the wake of the financial crisis of 2008, global central banks followed the Federal Reserve in moving to a zero-interest rate policy. I discussed this in my book Collusion.
They had no choice. Liquidity in the financial system had dried up. Central banks were the only liquidity game in town for the global banking community.
The same thing happened in the wake of the Covid-19 pandemic when the global economy shut down.
It’s a bit different now.
We had about two years of tightening policy to combat inflation, which was the Fed’s stance.
Then, central banks began taking a closer look at their national economies. They decided to act in their own best interests. They stopped following the Fed.
But that doesn’t mean the Fed will follow them. Not right away anyway.
Let me explain.
Two G7 Banks Put Growth Over Inflation
Last week, the European Central Bank (ECB) cut rates by 0.25% for the first time since 2019.
That’s even though inflation in the European Union (EU) is above 2%. And even though the ECB’s forecasts for future inflation are higher than 2% for 2025.
The Bank of Canada did the same a day earlier. It cut rates by 0.25% despite a lower-than-expected quarterly economic growth figure of 1.7%.
The Riksbank in Sweden cut rates by 0.25% in May. The Swiss National Bank Switzerland cut rates by 0.25% in March. They were not alone.
The central bank of Brazil has been cutting rates since last summer. The People’s Bank of China cut rates in February.
Yes, the world is pivoting to rate cuts.
But this does not mean that central banks can control supply-side or event-driven inflation or even reach and stay below their inflation targets.
It also doesn’t mean people aren’t feeling the pinch of higher rent, food, or energy costs.
But it does mean that central banks are accepting their inability to control inflation in the face of slowing economic growth.
As the Federal Open Market Committee (FOMC) heads to its June meeting this week, these latest G7 central bank cuts will have some resonating value.
They will likely come up in their internal conversation. They would look too disengaged with worldwide policy otherwise.
However, given the Fed’s stance from its last meeting, it would take too stark an about-face from a posturing perspective for it to cut rates this week.
The Fed Is at a Crossroads
As I’ve outlined before, the Fed is more likely to cut at the FOMC meeting in July.
That will give it time to hone its “we are seeing slowing growth, and inflation isn’t where we want it, but it’s in a lower band than before” message.
This will pave the path to a rate cut.
See, the Fed is at a crossroads of slowing growth and bank problems vs. inflation.
Last quarter’s U.S. GDP was revised downward to 1.3%. Despite this, the Fed did not underscore a slowing economy after its last meeting. There are other problems looming.
Last week, the Federal Deposit Insurance Corporation (FDIC) released its list of 63 problem banks nationwide. It emphasized these problems were due to mounting instability of commercial real estate loans.
Plus, U.S. banks are facing $517 billion worth of unrealized losses due to the Fed’s “higher for longer” interest rate policy.
The market is pricing in only one quarter-point cut in 2024. It is placing the odds of a September 0.25% cut at 50/50.
The May Consumer Price Index (CPI) data will be released on Wednesday.
Market expectations are for a 0.3% month-over-month rise in the core inflation rate, which excludes food and energy. And a drop in the annual rate down to 3.5% from 3.6%.
If we see anything dramatically different from those expectations, we could see some chop into the FOMC meeting announcement later that afternoon.
Let’s move on from inflation to jobs. This is another thorn in the Fed’s side.
The media touted Friday’s May jobs report as stronger than expected.
On its face, the addition of a greater-than-expected 272,000 jobs confirmed the tight labor market position the Fed has held for months.
U.S. Labor Secretary Julie Su heralded the Fed’s orchestration of a soft landing on the back of those figures. And the U.S. markets barely budged on the “better-than-expected” May U.S. jobs report.
But it wasn’t all that great. It also showed the unemployment rate ticked up to 4%. That 4% unemployment rate isn’t new, but it’s noteworthy. That’s where it landed after:
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The Covid-induced peak of 11%,
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The 2008 financial crisis interim peak of 9.8%,
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And the past interim peak of 10.8% in the wake of the savings and loan (S&L) crisis.
The only difference is that the Fed was in an easing cycle after those interim peaks. Now it isn’t.
This confirms that Fed policy is coincidental, not causal, to unemployment.
The Fed won’t admit that. But it will have to take notice of this unemployment rate rise.
That means the Fed has “cover” from the higher unemployment rate to step back from its concerns that the labor force is too tight.
In summary, U.S. growth is slowing, banks are flailing, and unemployment is rising.
Other central banks accepted they can’t control inflation to fall below 2% and stay there. The Fed will have to do the same.
I have written to you about this impossibility for months.
So I expect the FOMC to discuss the economic slowdown more this week. And I still expect a 0.25% rate cut in July.
The Fed could decide to push that to September if the CPI figure comes in higher than expected.
But that would be cutting it close to the November election. And the Fed might not want to be perceived as acting for political reasons.
What You Should Do
The tech-heavy Nasdaq index has tracked the S&P 500 upward this year.
That’s due to a combination of strong earnings from major AI-tech companies and overall market sentiment about a rate cut this year. Low rates favor growth companies, which don’t tend to provide high dividends to compete with higher rates.
The best way to take advantage of this overall rate pivot, or imminent Stage 3 environment, is to buy the Global X Artificial Intelligence and Technology ETF (AIQ) in increments. It covers a broad array of large companies involved in AI products, services, and hardware.
For example, if you have $1,000 to invest, break that up into $200 or $250 per month. That will allow you to take advantage of the upside in AI and tech relative to rate cuts. And it will still give you a hedge if impatience about rate cuts causes market volatility.
The other strategy is to continue investing in non-fiat assets such as gold, silver, and Bitcoin. These have held their value during this “guess when the Fed will cut rates” period.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins