The federal funds rate is headed even lower.
Yesterday saw a huge shift for the investing landscape. Donald Trump was elected president of the United States for a second time. Wall Street responded to the news with a broad-based rally in risk assets. The major indexes, like the S&P 500 and Nasdaq Composite, and crypto currencies rocketed higher as a result.
One of the reasons for the gains was a lack of investment exposure for momentum-based hedge funds. Due to close race and the uncertainty surrounding the election outcome, short-term oriented institutional investors reduced their risk exposure. That way, they wouldn’t hurt performance so late in the year.
But there are some more significant factors that drove yesterday’s rally. When Trump last occupied the Oval Office, he championed less government intervention and red tape. That means his administration will be more inclined to let the free-market decide how business gets done, rather than overbearing government regulators. Now, that doesn’t mean anything goes, but it does mean less oversight and investigations for the technology industry.
In addition, Trump is a proponent of a weaker dollar. He made this opinion well known in his first four years. He feels that will help drive demand for U.S.-made goods and juice the domestic economy. And he knows an easy way to get there: cheaper borrowing costs. Because, lower rates mean dollars will become more plentiful, driving down the value.
As a result, this next time around, like the last, he’s likely to follow a similar tack. He’ll ramp up pressure on the Fed to drop the federal funds rate and boost economic output. The change should boost demand for and the price of dollar-based risk assets like crypto currencies.
How can I be so certain? Let me explain.
In 1996, I got my first “real job” out of college. I got hired by a small brokerage firm in Richmond, VA, called Wheat First Butcher Singer. I took whatever opening I could find, to get my foot in the door. I saw this as my opportunity to start a long and successful career.
From the first day, I was determined to learn everything I could. I would pay attention to the habits of others that I saw as paths to success as well as those that ended in failure. I wanted to understand both, so I knew which practices to emulate and the pitfalls to avoid. And over the years since, I’ve incorporated those observations into all facets of my career.
You see, since 1996, I’ve experienced some of the best and worst stock market and economic environments possible. From the dot-com bubble to the financial crisis, to the COVID rebound. I’ve experienced a lot. But each time, I made notes to myself of what caused them and what helped pull us out. Because I knew similar events and environments would happen again, and I wanted to use my knowledge and experience to help people navigate them safely.
As a result, I’ve found one habit that continues to provide success time and again. By following the “bread-crumb trail” of data, I can get a sense of what’s happening economically. By knowing that, I can tell if our central bank is destined to adjust policy higher or lower. That’s important because when rates are falling, it usually means individuals and businesses have easier access to funds. That leads to more spending and economic growth.
The bread crumb trail I’m talking about refers to the fairy tale “Hansel and Gretel” by the Brothers Grimm. In the story, the two children’s step-mother has their father walk them deep into the woods to abandon them. The two leave a trail of small breadcrumbs, so they can find their way back out, once the adults are gone.
In finance, it’s not much different. To find out what’s going on economically, we must look at a number of different indicators. By studying these smaller pieces, and then considering them together, we can navigate our way down the complete economic path.
Based on recent indicators, domestic output continues to stabilize. That’s the outcome the Fed has been seeking since it started raising rates in 2022. The change should lead to another rate cut when policymakers meet today, and even more moving forward.
So, let’s look at a few to show you what I’m talking about.
First, let’s take a look at the employment picture. On Friday, the U.S. Bureau of Labor Statistics (“BLS”) released payroll numbers for October. That data showed that only 12,000 jobs were added during the month. At the same time, gains reported for the prior two months were reduced lower. And while that isn’t an ideal outcome, we must look at the bigger picture trend.
In the above chart, I looked at the average monthly gains for the three years leading up to the pandemic and the four years since. I left out 2020 due to the erratic swings up and down. But, by focusing on the average gains pre- and post-pandemic, we can get a sense of what typical hiring activity looks like.
As you can see in the above chart, due to all of the pandemic-driven stimulus, hiring data was distorted, But now as most of that money is gone, things are back to normal. So far this year, we’ve averaged about 170,000 job gains per month. That’s just below the 177,000 average experienced from 2017 through 2019.
Now let’s look at inflation growth.
The above chart shows us the change in the U.S. Bureau of Economic Analysis’ personal consumption expenditures (“PCE”) index over the last five years. The Fed prefers this gauge to the consumer price index (“CPI”) from the BLS because it measures not only the money consumers pay for but also those on their behalf, like medical benefits. By looking at that, policymakers get a better sense of the entire picture.
As you can see, from 2020 through 2023, stimulus money had an outsized effect on prices. People flush with money spent it, causing price growth to explode higher. But, as those pandemic savings have been spent, households are becoming more price-conscious. And, as we look to the right side of the chart, we can see PCE has receded back to pre-pandemic levels.
Lastly, let’s observe one last economic indicator: economic output. Last week, the BEA reported GDP rose 2.8% in the third quarter. That’s a pretty solid number. Yet, when we combine it with the 1.4% and 3% increases in the first and second quarters, we get an average pace of growth around 2.4% for the year. So, we want to frame that number compared to the longer-term picture.
You’ll notice the above chart looks similar to the last two. There’s a huge swing higher after COVID. But then as we move further out, the picture appears to be returning to normal levels of activity. In fact, the 2.4% average rate of growth so far this year is just above the 2.3% typical rate of growth since the financial crisis.
This all brings me back to central-bank policy. Based on the most recent PCE numbers, the real rate of interest (effective federal funds rate minus PCE) sits at 2.8%. In other words, our central bank can cut interest rates by another 280 basis points before borrowing costs stop weighing on inflation growth.
In March 2022, the Fed started raising interest rates due to the economic distortions it saw. We looked at the same aberrations above in labor, inflation, and economic output. However, now, all those measures have returned back to normal. Yet, monetary policy has not. So, like I said at the start, don’t be surprised when policymakers cut rates later this week and even more moving forward. And as this happens, it should support more stability in economic growth and underpin a steady rally in crypto investments like bitcoin and ether.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
