September into mid-October has historically been a dicey period for equities overall. Of course, history doesn’t mean much when the financial system is wrestling with so many “firsts.” Rather than red, it appears markets are waving a yellow flag of caution.
Wherever investors look, gut-wrenching changes are occurring in the economy, including trade and even the independence of our monetary system. However, at the same time, there are plenty of positive developments among these changes. Depending on your perspective, the cup is either half full or half empty.
The economy continues to grow, with the second-quarter GDP revised higher to 3.3 percent from 3 percent, after shrinking 0.5 percent in the first three months of the year. Most of those results were driven by changes in imports. The historically high tariffs announced by the Trump administration prompted businesses to import foreign goods ahead of their implementation. Imports, which are subtracted from GDP, caused the decline in the first quarter. That trend reversed in the second quarter as imports fell by almost 30 percent.
Economists expect the impact of the tariff taxes to begin to show up in earnest in the prices of a wide range of consumer goods. That, in turn, may fuel future inflation. A precursor to that was the most recent Producer Price Index, released a week ago, and the Personal Consumer Expenditures Index, announced on Friday. The PCE data for July came in as expected. Prices rose 2.6 percent year-over-year. Core inflation, which excludes food and energy, ticked higher from 2.8 percent to 2.9 percent.
Despite those indications of higher inflation, investors are expecting the Federal Reserve Bank to cut interest rates at their Sept. 17 meeting. There is a greater than 70 percent chance of one cut in September, with as many as two more by the end of the year. However, two data points, the August nonfarm payroll employment report and the August Consumer Price Index, will be released before the Fed meeting.
Wall Street economists are forecasting an inflation rate of 2.8 to 2.9 percent for the CPI, and the consensus for the employment numbers is for additional job losses. If these forecasts prove accurate, the Fed will need to decide what is more important: employment or inflation. The markets are betting that employment losses will outweigh inflation gains, and thus, there is a high probability of an interest rate cut.
Last week, I argued that one interest rate cut is all we can expect. I would be a “hawkish cut” with no more waiting in the wings. I am guessing that a rising inflation rate, which I expect to top 3.15 percent by the end of the year, will deter Fed officials from further easing of monetary policy unless another historical change were to occur.
I assume readers are aware by now of the feud between President Trump, Fed Chair Jerome Powell, and now Lisa Cook, a voting member of the Fed Board of Governors appointed by President Biden. President Trump’s decision to fire her for “cause,” followed by Cook’s countersuit, will be decided in the courts. If he wins, Trump would then be free to appoint yet another administration-friendly voting member to the central bank board. That would give him majority control of the six-member voting board.
The financial markets, both here and abroad, believe that if Trump succeeds in his effort to control the Fed, it will undermine the independence of the Federal Reserve Board and, with it, any trust in its actions. The Fed’s independence from the U.S. Treasury was established by Congress in 1952.
For the most part, the concern over Fed independence is primarily a concern of Wall Street. It is surprising, given the financial community’s backing of the President’s reelection and their continued financial support of his cause. What they fail to realize is that this administration, according to U.S. Treasury Secretary Bessent, is focused on Main Street rather than Wall Street.
In this case, the populists among us do not view the Federal Reserve Bank as a friend, nor have they seen beneficial results from its years of independence. As I explained last year in my four-part series of columns on regime change and the rise of populism, for decades, the Fed, through its top-down economic policies, benefited those who could borrow, but not those who couldn’t.
It unknowingly fostered decades of widening income inequality, the main angry engine of growth behind today’s populism. Rather than independence, many Americans see the Fed as simply another tool of the deep state. Don’t look to them to rescue the Fed.
The reasons behind the President’s push for control of monetary policy go far beyond simply reducing interest rates or replacing Jerome Powell. Please read my July column, “What is really behind the move to replace Fed Chair Jerome Powell,” for a better understanding of the ramifications of this historical challenge.
Between labor weakness, higher inflation fears, tariff issues, and now this Fed scare, you might wonder why markets continue to make new highs almost daily. It is because U.S. markets have become increasingly short-term in their focus. The options markets, as I have written in the past, increasingly determine the direction of the market. The tail wagging the dog syndrome, if you will.
Given that more than 60 percent of the trade on the options market involves zero-dated options that expire at the close of each day, the reasoning is straightforward. Look no further than the middle of September when the Fed meets. The overwhelming odds are in favor of a cut. Lower interest rates are good for the stock market.Â
Since Jerome Powell, President Trump, and the markets want the same thing — to see interest rates reduced in September — why worry about something else that may or may not happen until it does?
The narrative continues to be bullish. Most market participants accept the government’s assurances that all is well with the greatest economy, the lowest inflation, and the brightest future that anyone could imagine. Some might say investors are whistling past the graveyard.
The higher we go, the more perilous becomes the path we walk, and the narrower it becomes. Friday’s PCE data came in as expected, but the markets still sold off. Traders had expected better-than-expected data, but they didn’t get it. NVIDIA’s earnings were impressive, but the stock still sold off because the results were not strong enough to justify the hype.
I urge readers to pay special attention to the macroeconomic data in the next two weeks. The yellow flag is waving. Until unemployment rises dramatically or inflation surpasses a certain threshold, investors will continue to push stocks higher. The S&P 500 could reach 6,550-6,570, but not more than that without a correction.