In many ways, uncertainty around interest rate cuts is probably the most important question for the US in 2024 other than the perennial favorite: who will win the presidential election?

​We have already mentioned in passing that we think that US Federal will be reluctant to cut interest rates as soon or as aggressively as the market expects.

These expectations changed significantly in the first month of 2024. The rate cuts that were expected by investors to begin in March have now been moved to May/June.

This timeline got a further lift with the simply monstrous payroll number in January. On Friday we found out that the US added 353,000 jobs in January, which was double the estimates and showed that the US economy is still growing very strongly.

Here is what that US jobs' growth looks like compared to recent months:

Incredibly, despite being at basically full employment, the US is adding more and more jobs. That is tough to do.

Once again, the rumors of a US recession just around the corner have been grossly exaggerated.

Furthermore, this only strengthens our analysis and firm belief is that the Fed will cut rates only very reluctantly, if at all, in 2024.

This is important.

As the quote at the top of this newsletter attests, ultimately, individual earnings matter somewhat. Companies do have to make money.

But what matters more for the overall market, however, is liquidity in the system. Liquidity is how quickly an asset can be converted into cash. The amount of liquidity in the system is determined by a few factors but the largest and by the most significant is the US central bank.

By determining the price of capital they can go very far to determine the amount of liquidity in the system.

Here is the quote again:

“Earnings don’t move the overall market, it’s the Federal Reserve Board... focus on the central banks, and focus on the movement of liquidity... most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”

In practical terms it means that, for stock markets to go higher from here, something significant has to change in the circumstances of the US economy. That change doesn't have to be at the level of the central bank but it is the most likely outcome.

Why?

Well, the US economy could grow dramatically faster than expected. That is always possible but the US economy is a large and very slowly moving entity with hundreds of millions of participants and inputs. Creating a productivity boom is always possible and there are possibilities - artificial intelligence for one - but it is very difficult.

Instead, it is far easier and also more influential for a bunch of people to get together in a room in Washington, DC and decide: we are lowering the cost of capital.

So, the US Federal Reserve's actions aren't just important, they are easy to implement relative to the very difficult work of making the US more productive and dynamic.

The problem for today's investors is:

The US central bank is going to be very cautious about cutting interest rates.

This didn't seem like such a big deal way back in 2023.

Then it was a relief that the US economy was still resilient and inflation had come down significantly. The fact that this encouraged the Fed to stop raising interest rates was cause for celebration enough and then rapidly the expectation shifted to the first rate cut.

The problem, however, is is that the US economy is still doing rather well and the history of US monetary policy argues strongly for being hyper vigilant about making sure inflation is truly beaten.

As Chair Jay Powell said during Wednesday's press conference:

“It’s a highly consequential decision to start the process (of rate cuts).”

Put another way, it is difficult to see the case for lower interest rates when the US is still adding hundreds of thousands of new jobs every month.

Chair Powell's reluctance is no doubt coming from the very real fear of being a second Arthur Burns. Burns was the head of the Federal Reserve in the 1970 who famously thought he had inflation beat by 1974 only to see it roar back in the final years of the decade.

That second period of inflation was far more serious and consequential both for the US economy and the Fed's credibility. Arthur Burns is synonymous with failure and a cautionary tale for central bankers to this day.

​That is why we wrote about Arthur Burns and his mistakes back in early 2022 for a very good reason.​

We concluded with:

"The biggest mistake might have been cutting interest rates far too quickly before inflation had returned to a manageable level. Burns had assumed that prices would begin to fall as the downturn deepened and so he was safe stimulating the economy."

And also quoted a speech by Chair Powell at Jackson Hole in 2021 saying:

"History cautions against prematurely loosening policy."

So, we aren't sure the Federal Reserve's Governors will be interested in cutting rates even if inflation continues to dip towards the target. The risk of another inflationary surge is ever present in their minds.

What will change their mind?

It won't be the US election. The Fed Board will be under massive pressure to ease into the election but will do everything they can to resist it. Their credibility took a massive hit over inflation and they will be very reluctant to let the institution become further politicized.

We think there is really only one part of the economy that could flip the switch:

The job market.

Any weakness in the US job market will be very quickly seized on as proof that interest rates need to come down.

This is boring but both necessary and also easy to track. The monthly jobs report will be critical and it will likely take a few weak reports to really get the US central bank to act though that may depend on other details.

In conclusion, markets will struggle to keep racing ahead if investors don't get credible information to expect interest rate cuts in the months ahead. Right now, that is simply very difficult to see.

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