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John Norris (00:30):
Well, hello again everybody. This is John Norris at Trading Perspectives. As always, we have our good friend Sam Clement. Sam, say hello.
Sam Clement (00:35):
Hey John, how are you doing?
John Norris (00:36):
Sam? I’m doing fantastically today and you know who else is doing great.
Sam Clement (00:39):
Who’s that?
John Norris (00:40):
Everyone that predicted that the Federal Reserve would cut the overnight lending target rate by 50 basis points!
Sam Clement (00:46):
Pretty much anybody involved with the market nowadays.
John Norris (00:48):
Well, I still wasn’t quite so sure. It’s not that I didn’t think that they needed to or should have I just, I was thinking these guys are a bunch of academics, a bunch of bureaucrats. They’ve always been sort of very gradualists…the economic data is not so dire, or at least officially, that hey, we got to do something outside of the ordinary. So while I thought 50 basis points was the appropriate move, there was enough of a sort of a question mark on my head, would these bureaucrats do what they should do or just the old tried and true and let’s be as gradual as possible.
Sam Clement (01:20):
Yeah, there was a lot going on and the timing of it also added some question marks because people talk about the apolitical nature of the Federal Reserve or whether that’s true or not, but elections coming up, the perception at least that you’re supporting the party, that’s the incumbent if you’re starting to cut before. So the timing just made it more kind of questionable. But I think you and I were both on the same page. This was the right call. You take politics out of it, you take economic data and put it in the focal point and it was the right call. Inflation’s slown down significantly.
John Norris (01:55):
The labor market looks like it’s cooling off.
Sam Clement (01:57):
Things are cooling off a little bit, but
John Norris (01:59):
But nothing’s completely falling apart. It’s not that doomsday scenario. It’s not, oh my God, the devil’s coming to dinner or anything like that. Just sort of standard economic slowdown, what you might expect towards the tail end of economic cycle. And here I think the Fed is doing what it thinks it needs to do in order to have that proverbial self landing.
Sam Clement (02:18):
That’s right. And we talked about this earlier, and I had a speech where I mentioned this this morning and that the fear is that the porridge doesn’t go from too hot to too cold immediately. So even if things are getting worse, there’s going to be a time in between where things are pretty good. And so that’s the fear. Things are good right now, but we’ve moved from 3.9% to 4.2% unemployment. That’s still very strong.
John Norris (02:46):
I mean, listen, when I got started in the investment industry back in the early nineties, 4.2% unemployment rate would pretty much, we would’ve considered that pretty much full employment.
Sam Clement (02:57):
And I think that’s still largely full employment based on our current circumstances. So that’s the fear, but that’s what they’re trying to balance is the longer rates were what’s now too high, the more things were going to break or more pain there was going to be. So they had to bring them down and they had to bring them down relatively soon by most people’s estimation.
John Norris (03:17):
Well, and I agree with you, and they still have a long way to go, and if the dot plots on the statement yesterday are any indication of where this is all going, at least what the end game is, what the final result is, whatever you want to call it, probably three and a half percent, maybe three and a quarter on the overnight lending target from what I saw for next year.
(03:36):
We’re now at 5%. So that means that, hey, we still have another 150 basis points worth of cuts out there and we shall see whether or not that’s the magic bullet. But I do have to caution people who think that just because the Fed has cut the overnight lending target once, that doesn’t necessarily mean that hey, everything’s going to start coming up roses. These things take a little while to work through the system.
Sam Clement (04:02):
And some people talk about in the reality of it’s maybe a little murkier, but this kind of J curve where things actually slow down a little bit.
John Norris (04:10):
A J-curve …
Sam Clement (04:10):
Or things, if you picture capital J slowed down a little bit because of the expectation of rates to continue to go further down before people start really getting excited. So I’m not sure if that’s the case in reality, but you’re right. Either way,
John Norris (04:25):
I would hope they’re not doing too much talk about the J curve in that meeting.
Sam Clement (04:28):
I don’t think they are. But if I told you, you could get, again, we’re not talking mortgage rates, but you could get it at six right now, but you’re going to be able to get it at five in a few months.
John Norris (04:37):
Hey, I’d hold off!
Sam Clement (04:38):
You’d probably hold off a little. So maybe there is some impact with the expectation that rates are going to continue to come down.
John Norris (04:44):
And I’m glad that you brought up mortgages because for such a long period of time, people that are real estate brokers, agents, what have you have been bemoaning the fact that existing home sales, even new home sales, have not been exactly where they would like for them to be. Real estate market isn’t as hot for those people as they would like for it to be. People that sell furniture, people that do HVAC, I mean all of it. Just want to see a more vibrant residential real estate market. Do you think this one 50 basis point cut is all of a sudden going to be that B12 shot in the arm or backside of the residential real estate industry?
Sam Clement (05:23):
I don’t, but it’s less about the cut itself and maybe this posture of further easing that I think could help it a little bit down the road. But when we talk about rates coming down, we’re talking about basically the one rate that the Fed controls.
John Norris (05:39):
That’s right.
Sam Clement (05:39):
And by association, short-term treasuries, but they don’t control the mortgage market.
John Norris (05:46):
No.
Sam Clement (05:47):
They can help it…
John Norris (05:47):
Not directly
Sam Clement (05:48):
I mean, but it’s tied closer to the 10 year, which by and large is supply and demand and economic conditions. So maybe they support economic conditions, but that should maybe bring rates higher. So I think that’s a long-winded way of saying I don’t think the 50 point cut is going to be this panacea for this slowdown in the housing market.
John Norris (06:07):
I think you’re absolutely right on that. I think unless you want to take out some sort of floating rate mortgage, which I would recommend if you’ve got to do something like that right now, you take out a floating rate mortgage when interest rates are going down, right Sam? You don’t take it when they’re going up.
Sam Clement (06:23):
If you have to take one out.
John Norris (06:25):
If you have to take one out.
Sam Clement (06:25):
If you don’t, you should probably never take one out.
John Norris (06:28):
Sam is not a fan of floating rate mortgages. Doesn’t sound like it.
Sam Clement (06:31):
I’m not.
John Norris (06:32):
Alright, but those people that have been maintaining a debt, some sort of balance on their revolving debt, their credit card, their home equity line of credit or what have you, anything that floats against the benchmark, be it prime or SOFR, the old LIBOR or whatever it is, three month T-bills, whatever it is, anything like that is all of a sudden you’re going to get a little bit of a break. It’s not going to be a massive break. I mean 50 basis points on 10,000 or something like that. I mean it’s not going to necessarily change your lifestyle. Is that $500 a year? Forty bucks a month? That’s certainly going to help. But it’s all of a sudden when we start looking at, hey, going down to three and a half on the overnight lending target? That takes prime down to six and a half, which all of a sudden is two percentage points lower than where it has been. That’s when all of a sudden those people that have built up a balance on their revolving debt start to feel a little bit of a relief I guess you should say.
Sam Clement (07:31):
Yeah, except those credit cards going from 24% to 22% over time? Hey, making progress!
John Norris (07:38):
Every little bit helps.
Sam Clement (07:39):
I mean, yes, it does start to alleviate some pain in borrowers, but then there’s this flip side where people, it’s been very stimulative to have this much income coming in for so many people taking zero risk. And so that’s the other side of it. I mean the risk-free rate’s been over 5%. You have a million dollars, which again is not the normal person, but a million dollars just sitting in a savings account, that’s $50,000 a year for doing zero.
John Norris (08:13):
Zero risk. That brings up a very valid question. Now, while the Fed only really controls the overnight rate and the discount rate on a few other rates, but seriously, the overnight rate is the one that everyone pays most attention to. And indirectly the bill market generally tends to follow suit. I mean it’s just got the overnight rate and short-term or money market rates are generally set off the overnight rate. Pretty strong positive correlation there. What does this mean? As you mentioned, the person with a million dollars in their savings or money market account earning 5% moving forward, they’re making four and a half, they’re making four, they’re making three and a half. Wherever the fed takes us on this do, all of a sudden, they start going, okay, well the 5% or 5.35 or whatever it was, felt pretty good. I’m not crazy. About three and a half, does that money go back into the markets?
Sam Clement (09:10):
I’m sure a little does, but the question, and I don’t have the great answer to it…
John Norris (09:15):
You can look in the crystal ball right there.
Sam Clement (09:17):
I’m looking at it
John Norris (09:18):
Two feet away from you…
Sam Clement (09:18):
And I do not see the answer to my question.
John Norris (09:20):
Oh, there you go. Alright, you sure?
Sam Clement (09:22):
But if someone decides that, Hey, this cash on the sidelines, I’m going to go buy some stocks with it, that means someone else is selling stocks.
John Norris (09:29):
Yeah.
Sam Clement (09:31):
So yes, I think there’s probably some incremental demand, but I think a lot of this money that we’ve seen, people are quoting how much cash is on the sideline, how much cash is in money markets. I think a lot of that is excess bank reserves that is then going to funnel back into the banking system.
John Norris (09:46):
Well, and that brings up a very interesting point because right now if you were to take a look at deposits across the entire banking system, what you would find is the larger banks, the money center banks, and a lot of the brokerage firms are sitting on mounds of deposits.
(10:05):
I mean, their loan to deposit ratio is 60, I mean they’re just sitting on a tunnel. However, when you get down a little bit, sort of your regional banks, what have you, you’re starting to look at some loan to deposit ratios north of 85, 90% meaning that, hey, they’re pretty full up on loans. There’s not a lot of leeway there. There’s not a lot of give. So what will happen if all of a sudden, hey, that person with a million bucks in the money market account or 250k or whatever it is, goes, I’m not making that 5% anymore. I’m making three and a half or I’m making four. I’m going to take even half of that and go buy an S&P 500 index fund or something like that. What do you think that could mean for the banking industry as banks all of a sudden are really fighting it out, trying to maintain those deposits so they continue to make loans?
Sam Clement (11:01):
And it’s a great point and I think you have to differentiate, and you really were gearing it up for this, but the difference between those money center banks and the regional /community banks, because the money center banks, their average cost of deposits by and large is still less than half a percent.
(11:18):
I mean their “yield curve,” what they were borrowing versus what they’re lending at, that’s been pretty steep this whole time. This has been fantastic. This higher rate environment. The non-money center banks are where they’ve really had to fight more for deposits and obviously the cost of borrowing for the banks to the deposits is much closer to the risk-free rate than for those money center banks. So that’s where a lot of that competition is going to be is in those regional / community banks because those large banks, people aren’t just going to JP Morgan for the highest rate.
John Norris (11:54):
They’re other reasons knowing that hey,
Sam Clement (11:56):
Too big to fail…
John Norris (11:57):
Too big to fail. And if I’ve got, let’s say I’m Warbucks or whatnot and I’ve got a million dollars, I don’t want to keep in deposit again, that person with a million bucks in the money market account, 250k is insured by the federal government. Whether or not the federal government actually has the money to insure, that’s beside the point. But 250k is insured by the FTIC, right? Remaining 750k is not, at least if they don’t,
Sam Clement (12:20):
Apparently
John Norris (12:21):
If they don’t sort of stagger it and all that, there’s ways to kind of layer that. Well, if that’s the case, would you feel more comfortable at Joe-Blow Bank or JP Morgan Bank, understand that the treasury or Washington literally cannot let JP Morgan fail.
Sam Clement (12:42):
Well, if my…
John Norris (12:43):
The answer’s obvious to me.
Sam Clement (12:44):
Yeah, if my job’s on the line, if my job is to protect my company’s deposits, that is a huge weighting towards where we decide to bank with.
John Norris (12:53):
Yes,
Sam Clement (12:54):
It’s not the only one. Maybe if someone’s paying 5% and the money center’s paying you zero, okay, maybe there’s a tipping point to that, but that’s… and arguably the most important thing is to first not lose your money. So I mean, it’s hard to overemphasize the importance of that. And that’s why that plus the massive retail deposit base for most of these banks. I mean billions and billions sitting at 0% interest in checking accounts, they have tens of millions of accounts. So those money center banks are fine in terms of the cost of deposits. They’re frankly, probably their margins are probably going to get squeezed a little bit more maybe? So we’ll see what happens with the regionals and the community banks that have had to fight it out a little bit more.
John Norris (13:44):
And I think we or they, or whomever, however you want to phrase it, they’ll fight it. They will have to continue to fight it out and pay attention to what their competition’s doing when terms of deposit rates and what have you. But a couple of weeks ago I wrote in Common Cents about how it’s going to be the first person, that first firm that cuts their deposit rates and everyone else is going to make a mad sprint to the door. And I do think that’s going to happen, particularly now that they cut it 50, had it been 25?
Sam Clement (14:11):
Maybe hold out…
John Norris (14:12):
People might’ve: “Okay, let’s hold on and we’ll get it the next one it’s only six weeks,” now that it’s 50, I think it’s a little bit different story on that. So I imagine that you’ll start to see banks that have banks that are paying up for the deposits will start cutting them relatively short.
Sam Clement (14:28):
Yeah, and the other big thing I’ve heard since cutting rates or really even before, is that cutting is not good for the market. I hear that all the time and there’s cases where that’s the truth, but there’s also cases where that’s not the case where the market does like easing, and it’s really down to one big question: are we easing because the economy’s significantly slowing or are we doing this as a tinkering of policy, a kind of renormalization of policy?
John Norris (14:55):
And that’s a great question. If you’re of a certain age, you might remember the expression that’s the $64,000 question. I’m not even old enough to remember that, but somehow I do.
Sam Clement (15:08):
I know the saying.
John Norris (15:08):
Yeah, you know, you’re right. Because if you’re cutting because you’re too late to the game and you do a panic cut, it’s 2008, it’s too late. This right now, at least according to the official data, suggests that they aren’t too late. They might be preemptive. You have to remember the second quarter GDP report is what, 3%? We’re still looking at unemployment at 4.2%, officially.
Sam Clement (15:39):
3% for this next quarter estimates.
John Norris (15:42):
And so we’re taking a look at things going, no, they’re not. I don’t think they’re being reactionary. I think they’re taking a look at data as it comes in. We’re seeing the last CPI report was probably the best CPI report I’ve seen in a while. Although the numbers weren’t shocking, 2% for the overall and boy, not 2%, two tenths of one percentage point, then three tenths of one percentage point for the core. But there were a lot of negative signs in the report. So I mean, I think the data sufficiently weak enough that the Fed can get away with a 50 basis point cut and just say, Hey, we’re just trying to get up the curve here.
Sam Clement (16:25):
We are jump starting it.
John Norris (16:26):
That’s all we’re trying to do. I could have even argued a hundred, however, that hundred basis point cut would’ve probably triggered all kinds of alarms and freak out bells and all that stuff. So 50 is the right call.
Sam Clement (16:43):
Yeah, if you could mute all these other variables about the implied fear by doing a hundred, if you could just get it back to where we think a more normalized at R Star, they talk about a hundred basis points. Get it down to get it down to four and a half, see where things are.
John Norris (17:03):
Yeah, I mean, get it down to 4% fully, completely flatten the yield curve and let’s take it from there. So here we have it finally, September 18th, 2024, after talking about a Fed rate cut for, going on two years, but really, I mean probably about 18-19 months really seriously. The Fed finally delivers on one. I’m not sure the markets really completely understand what it means in terms of overall economic activity. Yesterday, the stock market loved it at first, but largely we closed the day roughly flat.
(17:40):
And here today on the 19th of September, the stock market loves it again The bond market hadn’t really loved it, and I think for good reasons, you make money cheaper, inflation expectations creep up, and that’s historically the way it’s been. However, I think the magnitude of today’s rally will probably dissipate over time as people realize, Hey, this stuff isn’t going to show up immediately in the data. It’s going to take a minimum of a couple quarters to have any sort of real true impact, and the economy might continue to soften over the next couple of quarters despite the fact that we’ve already had this one rate cut.
Sam Clement (18:15):
Yeah, the big change from yesterday to today for me is that we can now fully, it seems like, celebrate good economic data. For a large part of the last two plus years, I mean, we’ve gotten so backwards that we’re…
John Norris (18:32):
Keeping the Fed on the sidelines.
Sam Clement (18:33):
Good data was… the market would sell off on good data and rally on bad data because that meant we were closer to, we just needed another rate cut injected in our veins. But the Fed has clearly made it apparent that they have started the cutting cycle. This was not a one-time, 50.
John Norris (18:53):
Jay Powell said as much.
Sam Clement (18:54):
He said they have started the cutting cycle.
John Norris (18:57):
The target appears to be three and a half.
Sam Clement (19:01):
So that creates this nirvana for markets. If you are in a cutting environment where the economy and the individual companies are still chugging along. So we can now fully celebrate that good economic data doesn’t mean we’re not getting rate cuts anymore. The only thing is, if we got some horrible inflation data, which I don’t see in the next few prints, at least.
John Norris (19:22):
I don’t see that happening either. Actually, I don’t see that happening at all. At all. At least not for the foreseeable future, unless all of a sudden we decide to print an additional $5 trillion worth of cash, which we did in 2020, which you never know. We might be willing to do that 2025. Well, actually, Sam, I think if nothing else, it was fun to talk about something else besides the election and conversation here over the last couple days. Everyone wanted to know just exactly what our thoughts were on not only the rate cute, but then also what Jay Powell had to say about it. And just, I think really my general thought process is, again, just kind of sum up really my take on it is they did what they had to do. They were a little bit more aggressive than I thought they’d be, but I would’ve done 50 basis points as well.
(20:10):
And I thought the academics and bureaucrats in them were going to be more gradual than the 50 basis point rate cut. I applaud it. I think it’s fantastic. I want some more of it. I don’t think it’s necessarily that it’s a massive rocket for the economy or anything like that. It’ll take a couple of quarters for it to fully have to start to have some impact. But the yield curve has been inverted for too long. Some sectors of the economy have hurt more than others, and this really appears as though things have kind of stabilized. There’s no reason to keep the yield curve as inverted as it has been. No reason to keep that overnight rate as high as it has been when longer term rates are significantly lower. So let’s go ahead and let’s try to normalize the cost of money in the U.S. economy, and hopefully things can get back to normal.
Sam Clement (20:56):
Sounds like a soft landing.
John Norris (20:57):
It sounds like a soft landing, which by the way, I had a very soft landing this morning coming in from Baltimore on Southwest I was happy we made it.
Sam Clement (21:07):
Love it.
John Norris (21:07):
Alright, guys, thank you all so much for listening. We always love to hear from you all. So if you have any comments or questions, please by all means, let us know. You can always drop us a line at , or you can leave us a review on the podcast out of your choice. If you’re interested in reading more or hearing more what we got to say or how we think, please by all means, go to oak worth.com, O-A-K-W-O-R-T H.com. Take a look underneath Thought Leadership tab and find links to all kinds of exciting information, including previous podcast of Trading Perspectives, links to our newsletter slash blog Common Cents, as well as links to our quarterly economic analysis and breakdown, all that good stuff called Macro Market and all its independent pieces, as well as other thought leadership pieces by our client advisors and Mac Frasier and his staff over on the advisory services team.
(21:56):
So with that, Sam, I’m going to give you last chance to say something really awesome on this topic. That’s all I’ve got. That’s all I’ve got today too. Y’all take care.