Market Commentary – Why I Believe Rate Cuts are Overdue
By: Eric Sterner, CFA, CAIA, FRM, CIPM
Chief Investment Officer, Apollon Wealth Management and Apollon Financial
There’s been much debate over the past several months if it was time for the Fed to reinitiate rate cuts. The Fed had cut rates several times last fall with a 50-bps cut in September, a 25-bps cut in November, and a 25-bps cut in December. Since then, the Fed has been on hold due to trade policy uncertainty as well as concerns on how tariffs may impact inflation. While there have been two Fed officials, Christopher Waller and Michelle Bowman, who have been vocal in support of reinitiating rate cuts over the past several months, the rest of the Fed has remained hawkish. However, the tide is quickly turning, and the major pivot seems to have occurred at the Federal Reserve’s 2025 Jackson Hole Economic Policy Symposium. Fed Chairman Jerome Powell delivered a speech in Jackson Hole, which ignited a market rally. The odds of a September rate cut before Powell’s speech was roughly 65%, but those market-implied odds jumped over 90% when Powell was done talking. There’s a “reasonable base case that tariff effects will be relatively short lived”, and the “shifting balance of risk may warrant adjusting our policy stance” are two of the key phrases that reenergized the market rally.
I’ve been vocal for several months with my concern that the Fed was falling behind the curve. While I’m excited that the probabilities of a rate cut are very high for the Fed’s meeting this month, I believe the Fed should have acted sooner to avoid any unnecessary labor market deterioration. Here are some data points to support my view over the past several months.
Small Company Struggles
Over the summer, many economists stated the economy and stock market are doing fine and don’t need rate cuts. Those folks regularly pointed to the stock market, specifically the S&P 500, to support that statement. There’s no denying the fact that the S&P 500 was up over 25% in 2024 and is up over 10% year-to-date as of the end of August. However, the S&P 500 does not represent the overall US economy. The S&P 500 represents large cap stocks and it’s been well documented that the majority of those great returns have been driven by the Mega Techs, thanks to the strength of the AI movement.
Smaller companies, on the other hand, are struggling as they typically do under higher, restrictive rates. Small cap stocks tend to have more floating-rate debt – approximately 40% of Russell 2000 debt (excluding financial firms) is floating rate, compared to less than 10% for the S&P 500 according to JP Morgan – and small caps’ fixed rate debt has a shorter average maturity.
When policy rates are elevated, small cap earnings tend to suffer more than larger companies. These struggles have been evident in the labor market reports over the past several months. According to ADP Private Payrolls reports, larger companies (more than 500 employees) have added 93,000 jobs since April. Small companies (less than 50 employees) have shed 34,000 jobs in that same time period. Small businesses with less than 50 employees account for more than 40% of private sector employment based upon ADP data. Therefore, struggles within these businesses can have major impacts on the overall US economy and consumer spending.
Source – ADP Private Payrolls Report
Disinflationary Trends Over The Past Several Months
Inflation has continued its slow downward trend this year, and we have not yet seen any major inflationary consequences because of tariffs. I believe many of the reinflationary fears may be a bit overblown. Inflation spiked after COVID due to massive fiscal stimulus, tight labor market conditions, and high money supply growth, which do not apply to today’s macro environment. Yes, we may see some small bumps in inflation over the coming months, but tariff-induced inflation is a one-time-tax-driven adjustment. Temporary import price increases do not merit restrictive policy, especially when it is not associated with tight labor markets or monetary expansion.
Additionally, core goods represent roughly 35% of the Personal Consumption Expenditures Price Index (“PCE”), which is the Fed’s preferred inflation report. Therefore, any core goods price changes need to be large enough to overcome the smaller weighting in the inflation basket to offset the disinflationary trends that remain underway within services components. July’s shelter costs, one of the stickiest components of CPI, trended below 4% for the fifth month in a row. This is the first time it has held this level in approximately five years.
The Frozen Housing Market
The housing market is a major component of the overall US economy and typically contributes 15 – 18% to GDP. However, the housing market has been stuck in a ditch recently as it just experienced its worst Spring in 13 years. Mortgage rates remain elevated, which is causing a house affordability issue for many consumers. Mortgage rates are most closely correlated with the 10-year Treasury yield, but the Fed’s benchmark rate also has an indirect relationship with those mortgage rates. When the Fed lowers rates, it can help stimulate the economy by making borrowing cheaper. We need to restore some health into the housing market to help sustain US economic growth. I don’t believe we will see mortgage rates as low as pre-pandemic levels anytime soon, but lowering the rates can certainly help address the housing affordability issue in the US.
Conclusion
Maintaining price stability is absolutely critical to the long-term health of any economy. The Fed made the right move when it aggressively raised rates after the pandemic to bring down inflation. Some may argue that the Fed was too late to raise rates back then, but that is behind us. If inflation was still untamed and not showing signs of slowly moving downward, I would 100% support the Fed maintaining restrictive rates even if it pushed the US economy into a recession. However, that is not the case today as the disinflationary trend has been evident in the various inflation reports throughout this year. The road to bring inflation down to 2% will be bumpy and will take time.
In my opinion, the Fed should have reinitiated rate cuts earlier this summer. The labor market is traditionally the last economic indicator to fall before a recession. Historically, as the unemployment rate has moved up, it can quickly increase its velocity leading to an economic downturn. While a recession is not my base case, if the Fed does not reinitiate rate cuts soon, it may unnecessarily increase the odds of a recession. The good news is it seems like the tide may be turning and we may hear more dovish messages coming from the Fed this fall. A soft landing is still my base case.
Apollon Wealth Management, LLC provide advice and make recommendations based on the specific needs and circumstances of each client. For clients with managed accounts, Apollon has discretionary authority over investment decisions. Investing involves risk and clients should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing price to make decisions. The information contained herein is intended for information purposes only, is not a recommendation to buy or sell any security and should not be considered investment advice. Market performance information and projections have been provided by third-party sources and, although believed to be reliable, have not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change. Past performance is no guarantee of future performance. Please contact your financial advisor with questions about your specific needs and circumstances.
