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To investors,

The stock market and US economy are at a crossroads. Does the economy remain resilient? Will stocks continue to appreciate? Or is a recession right around the corner ready to punish investors and savers alike?

These are the questions market participants are struggling with this week.

Let’s dig in to the mess.

First, Bloomberg’s Katie Greifeld explains that two weeks ago was the worst week in the stock market, but last week was the best week of performance this year.

One reason for this surge in performance is the expected interest rate cut this week, but I don’t think you can exclusively point to that development. Remember, Fed Chairman Powell tipped his hand on the rate cut weeks ago.

Another key contributor was pointed out by the research team at Game of Trades — the M2 money supply is expanding again.

Money is flowing into the economy. And that money is about to get a lot cheaper in the coming months.

But knowing “cheaper” capital is coming doesn’t provide enough data for many investors. They want to know whether the Fed is going to cut 25 basis points or 50 basis points on Wednesday.

All signals indicate the Fed is prepping for a 25 basis point cut, but many economists, Fed officials, and investors have voiced concern that a smaller rate cut may not have the intended impact to stimulate the economy.

Liz Capo McCormick and Jonnelle Marte write for Bloomberg:

“The consequences of falling behind can be severe. Only once in its history — in the mid-1990s according to former Fed Vice Chair Alan Blinder — has the US central bank pulled off a clear soft landing. That’s when high rates are imposed just long enough to beat down inflation without tipping an economy into recession.

More often they have triggered a downturn. Leaving aside the pandemic crash of 2020, the six recessions over the past 50 years pushed unemployment to an average peak of 8.6%. Anything like that would throw millions out of work.”

The market has quickly started to change their tune — Fred Krueger shows the expectation has shifted towards a 50 basis point cut after a Wall Street Journal article by Greg Ip argued for the larger cut.

The Fed can’t just implement big interest rate cuts without consequence though. If the central bank cuts rates too aggressively, combined with the monetary expansion, and the risk of rising inflation could quickly re-enter the picture.

Cut rates too slow and you may have a recession on your hands. Cut rates too fast and you may have high inflation on your hands. Lose-lose situation for the Fed. I don’t envy the position they are in.

Lastly, to add to the complexity, the bond market is predicting the Fed will have to accelerate their rate cuts because of the degradation in various economic metrics. The Kobeissi Letter writes:

“The difference between the 2-year Treasury yield and the Fed interest rates dropped to -1.69%, the most in at least 35 years. This gap is now even larger than in 2008 and in 1989, a few months before the recession began.

The 2-year Treasury yield is considered a leading indicator for the next Fed’s interest rate moves. In other words, the bond market expects that the Fed will be cutting rates at a rapid pace in the coming months.

This has been driven by increasing evidence of the deteriorating labor market and many indicators suggesting this trend will continue.”

No one knows what the Fed is going to do. No one knows what will happen with the economic data. And no one knows what the perfect balance should be for this interest rate cut.

What we do know is that asset prices should benefit from cheaper capital flowing through the economy, regardless of how fast the capital comes or how cheap it ends up being.

Hope you all have a great start to your week. I’ll talk to everyone tomorrow.

-Anthony Pompliano

Founder & CEO, Professional Capital Management

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