We agree with the Federal Reserve’s (Fed) decision to cut rates by 50 basis points. As we will explain, our own analysis of data throughout the past few months confirms the necessity of the Fed’s September rate cut but also highlights a potential underestimation of the economy’s weakening momentum since spring.

In reviewing the Federal Reserve’s monetary policy actions throughout 2024, it’s essential to juxtapose their observations with our own insights derived from the WCA Barometer. The Barometer, a diffusion index measuring various economic inputs, provides a nuanced perspective on the evolving economic conditions.

We use the WCA Barometer to decide our tactical exposure to stocks versus bonds in tactically allocated portfolios. As the Barometer’s forecast path moves down, we lower equity exposure (increase bond exposure) to align with its forecast value. Conversely, when the Barometer rises, we increase equity exposure (lower bond exposure) to align the equity weight with its forecast value. Accordingly, we began reducing equity exposure from about 70% exposure in March to 60% in July and finally to under 50% today.

WCA Barometer

When we align the Fed’s statements with the Barometer’s readings, we uncover areas of confirmation and contradiction that shed light on the underlying dynamics influencing policy decisions.

WCA Barometer Trends (December 2022 – August 2024):

2022 to Mid 2023: Starting at a modest 25 in January 2022, the WCA Barometer climbed steadily, reaching 60 by May 2023. This upward trajectory indicated improving economic conditions, aligning with the Fed’s observations of solid economic activity and strong job gains during this period.

Mid to Late 2023: The Barometer fluctuated from June to November 2023 but remained relatively high, averaging around 54 to 63. This consistency suggested sustained economic momentum, which the Fed acknowledged by maintaining interest rates and focusing on inflation risks.

Early 2024: The Barometer peaked at 72 in January 2024, signaling robust economic health. However, by May 2024, it began declining, dropping to 67 and reaching 60 in July.

August 2024: Notably, the Barometer took a significant dip to 49.6, falling below the 50 threshold that typically separates expansion from contraction in diffusion indices. This drop indicates a potential slowdown or contraction in economic activity.

Barometer Forecast (September 2024 – December 2024): The near-term forecast projects the WCA Barometer to continue its downward trend, with point forecasts of 45 in September and stabilizing around 42 in November before a slight uptick to 47 in December.

Increasing Uncertainty

We note that uncertainty is rising. This can be seen in three ways:

1. Some of the contradictions in the Federal Reserve’s communication. For example, at his press conference yesterday, Chair Powell said “There is no sense the committee feels it is in a rush to do this. I do not think that anyone should look at this and say ‘Oh, this is the new pace.’” So, if the committee is in no rush, why did they go with a 50 basis point cut as opposed to 25?
   
2. The dissent by Governor Bowman to the September policy change – The first non-unanimous Fed decision since 2005.
   
3. Widening confidence intervals for our own WCA Barometer forecasts.

Widening forecast dispersion in our WCA Barometer forecasts is consistent with the economic ambiguity noted in the Federal Reserve’s latest policy actions.

Squaring the WCA Barometer with Federal Reserve Observations

We thought it would be helpful to lay out how our WCA Barometer’s assessment of changing conditions squares up with what the Federal Reserve has been seeing. Here is a quick summary of how the WCA Barometer and the Fed have been viewing changes in economic activity, labor market conditions, and inflation throughout the year:

1. Economic Activity:

• The Fed’s View: Throughout 2024, the Fed consistently reported that economic activity continued to “expand at a solid pace,” even in their September statement.
• WCA Barometer: The decline in the Barometer from 72 in March to 49.6 in August suggests a significant slowdown, potentially contradicting the Fed’s assertion of solid economic activity in September.
• Implication: The WCA Barometer’s decline may indicate underlying weaknesses not fully captured in the Fed’s broader economic assessments or emerging trends that the Fed is beginning to acknowledge subtly.

2. Market Conditions:

• Fed’s View: By September, the Fed noted that “job gains have slowed, and the unemployment rate has moved up but remains low.”
• WCA Barometer: The drop below 50 in August could be reflecting softening in labor market conditions, which aligns with the Fed’s observation of slowing job gains.
• Implication: Both the Fed and the Barometer signal a cooling labor market, providing a consistent narrative on employment trends.

3. Inflation Trajectory:

• Fed’s View: Inflation made “further progress” toward the 2% objective by September but remained “somewhat elevated.”
• WCA Barometer: While the Barometer primarily measures economic activity, its decline could be associated with reduced inflationary pressures due to lower demand.
• Implication: The Barometer’s downward trend supports the Fed’s observation of easing inflation, as a slowing economy typically alleviates price pressures.

Fed’s Rate Cut vs. Barometer Decline

The Fed’s decision to cut rates in September aligns with the Barometer’s indication of a significant economic slowdown. The Barometer’s readings below 50 suggest contraction, which justifies monetary easing to stimulate the economy. However, the Fed maintained in their September statement that economic activity was still expanding at a solid pace, which contradicts the Barometer’s more pessimistic outlook.

The timing of policy actions also seems slow relative to our WCA Barometer’s changes. The Fed’s earlier reluctance to adjust rates caused the Fed’s easing actions to lag slightly behind our Barometer’s initial decline from a peak reached last spring. The Barometer began signaling a downturn as early as May 2024, whereas the Fed only acted in September, potentially highlighting a delay in acknowledging the slowdown. Because monetary policy impacts the economy with long and variable lags, delays in changing policy may lead to the Fed falling “behind the curve.” To avoid this fate, the Fed may have opted to go with the larger 50 basis point cut over the less aggressive 25 basis point option.

Conclusion

Integrating the WCA Barometer into our analysis provides valuable context for the Federal Reserve’s policy decisions in 2024. The Barometer’s decline from its peak in March to below 50 in August suggests a more pronounced economic slowdown than the Fed’s statements initially indicated. This divergence may explain the Fed’s seemingly abrupt rate cut in September despite their public assertion of solid economic activity.

Moreover, our WCA Barometer’s forward-looking nature and sensitivity to various economic inputs might have captured early signs of weakening that the Fed, focusing on lagging indicators like employment and inflation, was slower to recognize. Our forecast projecting continued softness into the end of the year further supports the need for a more accommodative monetary policy stance, which is what the Fed delivered in their September policy decision.

In essence, the WCA Barometer’s readings confirm the necessity of the Fed’s September rate cut but also highlight a potential underestimation of the economy’s weakening momentum earlier in the year. Incorporating our Barometer suggests that the Fed’s observations, while eventually aligning with the data, may have lagged behind real-time economic shifts captured by our index.

This analysis underscores the importance of utilizing diverse and timely economic indicators to inform decision-making for investors and policymakers alike. The Barometer’s insights may provide an early warning system, helping to anticipate shifts that might not yet be reflected in traditional economic measures or central bank communications.