The inconsistency between rate-cut projections and history … the CPI problem if Wall Street gets loads of cuts … if push comes to shove, what will the Fed choose? As I write Friday early-afternoon, the S&P is on pace to notch a 5-day win streak as it approaches a new all-time high. Let's enjoy it. But before we get too comfortable, let's peer farther down the road. The market faces two significant problems. Let's highlight them so that we're not taken by surprise, say, six-to-12 months from now. The first logic issue relates to how many quarter-point rate cuts Wall Street is pricing into stocks as it positions itself for a soft landing We're very likely to get a 25-basis-point interest rate cut next Wednesday Anything is possible, but the jumbo 50-basis-point cut probably isn't in the cards after this week's inflation reports showing that core monthly CPI and core PPI ran above estimates. But whether the cut is 25 or 50 basis points, what comes after next Wednesday? The CME Group's FedWatch Tool shows that traders are pricing in a total of 10 quarter-point cuts over the next 12 months (by September 2025). Here's where we need to dig in… We don't have many historical soft landings to evaluate because they've been rare, but what does history tell us about the size of rate cuts in the first 12 months of a rate-cutting cycle during a soft landing (as measured in quarter-point cuts)? Hint: it's not 10. What a study of "soft landings" tells us about the scope of likely rate cuts In late-1966, the Fed began cutting rates to prevent a recession after its rate-hiking campaign had slammed the brakes on the economy. In the first 12 months of this soft-landing rate-cutting cycle, the fed funds rate fell by 1.25 percentage points – the equivalent of five quarter-point cuts. In 1984, the Fed was backing off its aggressive rate-hiking campaign from the early '80s. This soft landing required more work. The Fed cut rates from 11.50% in mid-1984 to 9.50% in mid-1985 for the equivalent of eight quarter-point cuts. Then in 1994's soft landing, the Fed began cutting when the fed funds rate was at 6.0%. Twelve months later, it was down to 5.25% - just three quarter-point cuts. The average number of cuts in these three soft landings equates to 5.3 quarter-point cuts in the first 12 months of a rate-cutting cycle… Why is Wall Street pricing in double the number of cuts of an average soft landing? Now, every economic situation and potential soft landing is somewhat different. And an interest-rate-dove might argue that this many cuts are needed to more closely mirror the neutral rate or the inflation rate. But still, we need to recognize that 10 quarter-point rate cuts in 12 months would represent the biggest-cut campaign in a soft-landing history – twice as much as the recent average. | ADVERTISEMENT  According to tech legend Luke Lango, we could see another major market shock this coming Wednesday, September 18th.
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Details here. | Could Wall Street be getting this wrong? Sure. Wall Street gets it wrong a lot. Remember December of last year when traders were betting that we would enjoy – wait for it – seven quarter point cuts this year? Morningstar states the obvious: Traders have a poor track record for predicting the central bank's interest rate moves months in advance, though they tend to do better in the weeks immediately before a meeting. The funny thing is that this quote comes from a Morningstar article from January. It included this next line that hasn't aged well: …The countdown to rate cuts is well underway… …Market watchers are increasingly confident that the central bank will soon pivot to lowering interest rates. True – if "soon" means nine months later. Bottom line: Wall Street is predicting a soft landing but is pricing in a volume of cuts that flirts with hard-landing conditions. So, might 10 quarter-point cuts executed in a relatively healthy, soft-landing economy be too stimulative, putting upward pressure on inflation? Well, that dovetails into our second logic problem… The challenge of rate cuts, the housing market, and CPI Let's assume that the Fed is going to bring us a veritable slash-a-palooza over the next 12 months. What are the potential consequences? Let's back up to Wednesday… Our latest Consumer Price Index (CPI) reading this week showed that inflation climbed 2.5% from last year. On a month-over-month basis, CPI rose just 0.2%. This was a welcomed reading, showing that we've made tremendous strides in the battle against inflation. But when we dig into the CPI data, one category jumps out as bucking the trend… Shelter costs (think homes and apartments). It rose 0.5% month-over-month, 2.5Xing the overall CPI monthly climb of 0.2%. Housing commands a huge weighting within the CPI calculation. Specifically, it accounts for roughly 1/3rd of the entire CPI headline reading. So, as we look ahead to inflation over the next 12 months, we'd be wise to pay close attention to housing and rental price forecasts. With this as our background, what happens to shelter costs if the Fed engages in this 10-cut slash-a-thon that Wall Street is pricing in? The Catch-22 of lower rates on the housing market About one year ago, the 30-year fixed home loan hit a 23-year high of 7.79%. The combination of this elevated rate plus home prices that were 40% above pre-pandemic levels resulted in a frozen housing market. Since then, mortgage rates have fallen sharply as the market has become more confident about upcoming rate cuts (which affects the 10-year Treasury yield, which is the primary influence on mortgage rates). As I write Friday, the average 30-year fixed mortgage rate is down to 6.32%. How low does this rate need to go before thawing the housing market in a significant way? Here's Hannah Jones, senior economic research analyst at Realtor.com: Roughly 86% of outstanding mortgages have a rate of 6% or below, meaning rates will need to continue to trend lower to see a fully reenergized housing market. But with the average rate already at 6.32%, that's not a big distance to cover before things begin heating up. Meanwhile, the expectation of lower rates is already luring some buyers off the sidelines with a direct effect on home prices. Here's Realtor.com: Potential homebuyers who've been hanging out on the sidelines, waiting for median home prices to drop alongside interest rates, may want to brace themselves: Prices are rising—as of now. Indeed, the Realtor.com economic research team expects list prices to rise 4.6% by the end of the year. And falling mortgage rates just might be to blame. "If lower mortgage rates spark more buyer demand than inventory can keep up with, then prices may climb once again, eliminating the impact of lower rates," says Jones… What this means is that not only will more buyers start searching for homes, but many might also resort to offering over the asking price. Upward pressure on home prices is bad news for the shelter component of CPI… which is bad news for overall inflation… which is bad news for the Federal Reserve whose dual mandate includes stable prices, and whose war against inflation has been long and challenging. By the way, the forecast for rental rates is likely to create similar challenges for the Fed. Here's Rental Housing Journal: CoStar Group forecasts that as the new apartment supply is absorbed, new data shows there will be an increase in rents in 2025 and 2026, ending the lower prices "many renters have had over the last couple of years as a result of the post-COVID multifamily supply glut."
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Click here to see it. | Consider the tradeoff for the Fed Would Powell & Co. stop short of the market's expectation for 10 quarter-point cuts to pump the brakes on a potential flare-up in CPI? If so, what happens to the stock market when month-after-month of FOMC meetings disappoint as the Fed doesn't cut rates as hoped for? On the other hand, what if the Fed gives Wall Street the 10 quarter-point cuts it wants, which gooses stocks but pushes CPI inflation materially higher? Would the Fed say, "Meh, the CPI increase is higher purely due to housing. Everything else looks good. So, too bad to all you less-well-off homebuyers." Our hypergrowth expert Luke Lango believes that's exactly what the Fed should do. From his Innovation Investor Daily Notes on Wednesday: The headline [CPI] inflation rate dropped to 2.5%. Excluding shelter (which has proven to be unkillable, even by high rates, so the Fed should ignore it), inflation dropped to 1.1%. Whatever path the Fed chooses, as it appears today, there are two logical inconsistencies that suggest some price, rate, or market expectation is wrong, and will need adjusting over the next 12 months. I'm not the only one who has noticed this. Here's Mohamed El-Erian, former CEO/CIO at PIMCO: It is problematic in my mind that the market is pricing in so many rate cuts right now. There's this notion of a hard landing policy response to achieve a soft landing, that has got to be reconciled one way or another. The market's going to have to adjust at some point. We'll see. So, what do we do about this now? We can analyze this as much as we want, but any conclusion we come to must factor in the single most important detail in this entire discussion… The market's current price/trend/direction. In recent Digests, we've profiled Luke's trading framework, "stage analysis." The concept is simple – you restrict your buying only to stocks that are climbing in a Stage-2 breakout. Today, we can speculate about the Fed, rate cuts, mortgage rates, and home prices as much as we want, but it doesn't change the reality of today's market… Stocks remains in a bullish Stage-2 breakout, as is evidenced by the market's price and bullish price trend. So, what do we do? We use our analysis to prepare for what might be…but with a respect for what currently is, we remain with this market. If you missed Luke's presentation from earlier this week, click here for the free replay to get more details. So, while we enjoy this climbing market and look forward to even higher prices to come, let's not be blind to the fact that the Wall Street wants to have its cake and eat it too. History suggests that's unlikely to happen…eventually. We'll keep you updated. Have a good evening, Jeff Remsburg | 
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