July 15, 2024: Projections for a slowly declining inflation rate appears to be on track and by the beginning of 2025 the Fed’s inflation target of 2% may become more or less realized. The mean’s the Fed chose to reduce inflation has involved an attempt to slow aggregate demand growth relative to that of aggregate supply and thereby put downward pressure on the average level of prices in the economy. They have not engaged in any activist monetary policy through the bond markets. In fact, if you look at the “Treasury Security Operational Details” of the Fed’s open market committee you will note that the Fed has actually been a net buyer of Treasury Securities since January of 2023. The M2 aggregate of the money supply has been increased along with these Treasury purchases. Increases in the money supply are always inflationary. Thus the Fed has relied on Treasury auctions of it’s refinanced balance sheet roll-offs to help soak up the excess monetary liquidity. Luckily, these roll-offs are relatively steep. Previously weak treasury auctions have not helped much in soaking up excess money supply growth, but more recently, treasury auctions have met stronger demand. Stronger demand for treasury auctions corresponds with projections for the M2 monetary aggregated to not grow and at least remain relatively constant into 2025.
Weakening the aggregated demand-side of the economy through higher short-term interest rates comes with risks. If the economy slows too much or too fast, a hard landing in the form of a recession could occur. Thus, at some point, the Fed has to put increasing weight on the labor market slowdown and a corresponding increase in the unemployment rate. With inflation coming down more significantly and unemployment finally, but grudgingly, inching upwards it looks more and more like the Fed will have to pivot and start lowing the short-term rates that it controls. The Fed controls its discount rate directly and the Federal Funds rate indirectly. The discount rate is the rate set by the Fed on loans money to member banks. The Federal Funds rate is a market determined overnight rate that member banks loan money to each other to meet their reserve requirements. The Federal Funds rates tends to be a little lower than the discount rate.
I expect the Fed to make this policy pivot sooner rather than later. This is because the Fed’s data is historical rather than contemporaneous and that could produce a Fed policy decision that is too late to avoid a recession — just as it was too late to avoid inflation when they started increasing rates. Chairman Powel seems increasingly likely to want to avoid being late twice in a row. Moreover, the market appears to expect this pivot as exemplified by small cap stocks, that are relatively more effected by greater leverage costs at higher interest rates, finally beginning to pick up steam.
Given this, some growth stocks to consider include: HRB, NOK, PYPL, AGS, VLRS, SPOT, VEOEY, BTMD, EGO, AMZN, ANF, GCT, CHEY, and RNG. Dividend growth stocks to look at include: NEP, NWL, TEF, TROW, and TXO. Over the previous three months, the fastest growing ETFs were: SMH, SOXQ, FTXL, SOXX, and XSD.
