F.A.C.O.

<July 10, 2025>

Speculation about a possible Fed rate cut in July has been building. Seeking clues, investors tuned into Jerome Powell’s June 24^th testimony before the House Financial Services Committee. Although Powell didn’t say much new and reaffirmed his wait-and-see approach, the bond market increased the odds of a rate cut in July and another later this year.

In addition to signals from the bond market, the Fed is under tremendous political and fiscal pressure to cut rates. Through thoughtful social media posts, President Trump continues to remind the Fed of his desire for significantly lower rates. On the fiscal side, rising interest expenses, massive deficit spending, and upcoming Treasury maturities certainly have the Fed’s attention. With the power to effortlessly reduce the government’s cost of capital and monetize debt, it must be tempting for the Fed to come to Washington’s rescue.

Before the Fed can wave its magical monetary wand, it would prefer to see sufficient data to justify an easing of policy. Based on current financial conditions and the broader operating environment, we don’t believe rate cuts are necessary. In aggregate, corporations enjoy record profit margins, tight credit spreads, and easy access to capital. The government continues to spend aggressively and freely, stimulating demand. Meanwhile, asset inflation remains unchecked, with stock prices at all-time highs and valuations near previous bubble peaks. Trading in stock options, leveraged ETFs, and crypto markets all point to overheated speculation.

At the same time, home prices and maintenance costs are pricing out a large percentage of the population. Household net worth and wealth inequality are off the charts. And while the inflation rate has declined, it appears to be bottoming and remains above the Fed’s target. Many companies continue to face rising costs and still retain pricing power. For consumers, years of accumulated inflation have created considerable affordability challenges. Workers need time for wages to catch up and compensate them for the last inflationary wave. Given this backdrop, the current Fed funds rate and real interest rates don’t appear restrictive.

While we don’t believe rate cuts are necessary, history has conditioned us to expect the Fed to err on the side of easy money. In our view, the bigger issue isn’t if the Fed cuts, but how the bond market responds when it does. The last 100 basis points of cuts likely didn’t go according to plan, with longer-term rates increasing.

A defiant bond market makes sense. Cutting short-term rates while stock and home prices sit at record highs risks reigniting inflation. With household net worth now exceeding $160 trillion—and companies increasingly targeting wealthy consumers—further asset inflation is more likely to spill over into the price of goods and services. At this stage in the cycle, the old playbook of stimulating growth through lower rates and higher asset prices may not just be ineffective, it could destabilize the bond market and prove counterproductive. 

During Powell’s tenure, the old playbook was used repeatedly. As a result, many investors did very well. However, those without inflated assets paid a heavy price, losing precious purchasing power as the cost of living surged. In effect, life under Powell has been great if you had sufficient assets. If you didn’t, you likely fell behind.

As Chairman Powell nears the end of his term, he likely has one eye on the finish line and the other on asset prices. While he may want to end his tenure as a monetary hawk, he surely wants to avoid a stock or housing market collapse on his watch—a lesson Chairman Greenspan learned the hard way!

We also expect Powell and the Fed to cite moderating inflation as justification for an eventual rate cut. But by focusing on the inflation rate instead of affordability, we believe the Fed is misreading the economy and consumers. Even as inflation has declined, affordability remains a serious issue. Based on our analysis of the businesses we follow, affordability—not inflation—is currently a far more important driver of consumer behavior.

If the Fed cuts rates and asset prices continue to inflate, we expect affordability challenges to worsen, discouraging more consumers and voters. Look no further than the recent mayor primary in New York, where Zohran Mamdani ran a successful campaign appealing to voters frustrated with the city’s rising cost of living. With stock prices soaring and voter desperation growing, politicians running on affordability and wealth inequality are likely to gain support.      

Will the Fed cut rates in July? We’re not sure. But we believe mounting fiscal pressure and Powell’s desire to hold the market together will eventually force their hand. While many see the return of easy money as bullish, we believe it’s unnecessary and risks causing additional asset inflation, bond market instability, and voter backlash. In the end, whether cuts are justified or not, we expect the Fed will cave. When it comes to letting free markets discipline Wall Street, speculators, and politicians, the Fed Always Chickens Out.  

Eric Cinnamond

eric@palmvalleycapital.com

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Definitions:

Leveraged ETFs: A leveraged exchange traded fund (LETF) is a security that uses financial derivatives and debt to amplify the returns of an underlying index or other assets it tracks.

Real Rates: A real interest rate is an interest rate that has been adjusted to remove the effects of inflation. Once adjusted, it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor.

S&P 500: The S&P 500 Index is a list of 500 of the largest public companies in the U.S. These companies are the biggest and most important companies in the country, and represent a broad cross-section of the economy.

Basis point: One one-hundredth of a percent, used especially in measuring yield differences among bonds.

Credit spreads: The difference in yield between two debt securities with different credit qualities but the same maturity, often used to assess the additional risk associated with corporate bonds compared to safer government bonds.

Consumer Price Index (CPI): Calculated by the Bureau of Labor Statistics (BLS), measures the monthly change in price for a figurative basket of goods and services.