Why a recession still worries this stock-market veteran, despite the Fed's rate cut

By Jonathan Burton

David Rosenberg: Best bets are long-term Treasury bonds and gold, plus utilities, real estate, financials and dividend-paying growth stocks

'The Fed moving 50 basis points was nothing more than an acknowledgement that it had stayed too tight for too long.'

The U.S. Federal Reserve came out swinging on Wednesday when it cut U.S. interest rates by half a percentage point. But whether the central bank's move is a hit, or a swing and a miss, remains to be seen.

Global stock markets cheered the Fed's decision. But David Rosenberg is staying in his seat for now. A former chief North American economist at Merrill Lynch and now president of Toronto-based Rosenberg Research, Rosenberg has been a vocal critic of Fed Chair Jerome Powell and the U.S. central bank. Wednesday's rate cut is the right move, Rosenberg says - but long overdue.

"The Fed moving 50 basis points was nothing more than an acknowledgement that it had stayed too tight for too long," Rosenberg said.

Rosenberg spoke with MarketWatch following the Fed's decision on Wednesday. In the following interview, which has been edited for length and clarity, the veteran market strategist detailed his view on what the Fed decision means for the U.S. economy and investment markets.

Rosenberg says he doesn't believe the Fed will move aggressively or urgently enough to keep the U.S. economy out of recession. He reasons that since the Fed was slow to fight inflation, it will be behind the curve to combat an economic slowdown. So Rosenberg is steering investors towards rate-sensitive assets that, while not necessarily recession-proof, are better-positioned to benefit from a Fed monetary easing cycle that he expects will take the federal funds rate down to a pre-Covid level of 1.75%.

Said Rosenberg: "The recession has been delayed but it has not been derailed."

MarketWatch: So what's your verdict on Wednesday's rate cut? Did the Fed finally get it right this time?

Rosenberg: There's two things to consider. This rate cut was already on the table at the last Fed meeting in late July. But they decided not to pull the trigger. So ordinarily they would have cut by 25 basis points then and 25 basis points now. The 50 basis-point cut basically acknowledges that they missed the opportunity to engage in the first rate cut six weeks ago; so they doubled down.

The U.S. stock market was already priced two-thirds of the way for a 50 basis point cut. So they basically delivered on what they market was already discounting. It was probably the appropriate move based on what they were thinking then and how the data have evolved since. So the 50 basis point cut made perfect sense to me.

MarketWatch: Does this move get us closer to the elusive "soft-landing" that Powell & Co. want for the economy - or is there another shoe to drop?

Rosenberg: The base-case scenario is that we are in a soft landing as things currently stand. If you pay attention to the tone in Fed Chair Jerome Powell's post-meeting press conference, the move was nothing more than a down payment, insuring that the soft landing, or the "goldilocks economy," remains intact.

MarketWatch: Do you believe that?

Rosenberg: No. I don't believe in fairy tales.

The FOMC is suffering from a classic case of cognitive dissonance. Monetary policy is still inordinately tight. The Fed moving 50 basis points was nothing more than an acknowledgement that it had stayed too tight for too long. All Powell did was do his best to sugar-coat the situation. How can he talk about the U.S. economy being solid at the same time he talked about downside risk to the labor market outweighing upside risk to inflation?

'Even as the Fed eases, the impact of what it has done in 2022 and 2023 is still staring us in the face.'

MarketWatch: Are you still concerned about an impending recession, or does the Fed's move here ease your mind?

Rosenberg: The Fed's move does not ease my mind one iota. Although they moved marginally less behind the economic curve, they are still way behind. In view of the 500 basis points-plus increase in the federal funds rate from the lows, this move, as large as it was, was only a dent. Even as the Fed eases, the impact of what it has done in 2022 and 2023 is still staring us in the face. There is no "get out of jail free" card for the economy, coming off the most acute tightening cycle since the Paul Volcker years of the 1980s. The recession has been delayed but it has not been derailed.

Look at the long list of anomalies in what Powell said. He calls the labor market solid, yet in his opening commentary he discusses how the employment data have been artificially overinflated. It's ridiculous to be discussing how solid the labor market is and at the same time how the data is overinflated. Powell was talking out both sides of his mouth.

What else did Powell do? At his press conference he invoked the Fed Beige Book. He wasn't asked. He brought up the Beige Book on his own. The Beige Book is not subject to revision. It provides tremendous color about what's happening around the country. It recently revealed that half of the country is in recession. We've applied data science to the latest Beige Book, and we see the same recessionary thumbprint we had in July 1990, March 2001 and December 2007. So yes, they are way behind the curve.

'Treasury bond investors can look forward to equity market-like returns.'

MarketWatch: What happens now for investors? Talk through the prospects for stocks, bonds, gold and the U.S. dollar.

Rosenberg: It means the 10-year U.S. Treasury note BX:TMUBMUSD10Y falls to 2.5% or lower, and Treasury bond investors can look forward to equity market-like returns. I'm telling clients you want to load up on long-dated zero coupon bonds because if my forecast is correct they will provide you with exorbitant returns over the next year.

In the stock market you want to be in sectors that perform well in a period of slower growth, lower inflation and lower interest rates. This would include utilities, telecom services, real estate, financials and dividend-paying growth stocks with high payout ratios. As for tech stocks and other investor favorites, ordinarily a lower discount rate would be good news. But multiples are still too stupidly high for me to be recommending them.

And gold? The cornerstone of my current portfolio strategy is the bond-bullion barbell. Rates are going lower; the U.S. dollar's (DX00) going lower, gold's (GC00) going higher.

MarketWatch: Are you concerned that this easing cycle will create a dangerous bubble for stocks?

Rosenberg: The stock market is already in a price bubble. There's a lot of optimism being priced in about what earnings are going to deliver over the next couple of years. Will the stock market be in a bigger bubble may be the case.

But the stock market is not part of the Fed's mandate. The labor market is. Stock investors should be concerned about recession and a lower earnings stream. That's where the equity market will struggle. If the Fed is cutting rates and there's no recession, the S&P 500 SPX will be up. If we get a recession, even with rate cuts, the equity market will be down.

Read: Here's when falling interest rates will hit your mortgage, car loan, credit-card bills and savings accounts

'I wouldn't be surprised to see two more 50 basis point cuts.'

MarketWatch: Maybe rate cuts are one and done for 2024. What do you expect and, importantly, what should investors realistically expect?

Rosenberg: There are two Fed meetings left and I wouldn't be surprised to see two more 50 basis point cuts. But the question is, what's the destination point? Look at what Powell said at Jackson Hole in August: The labor market and the inflation pressure points are back to where they were pre-Covid in early 2020. Where was the fed funds rate before Covid? At 1.75%. Ergo, we're going back to 1.75. I don't know if it's in 2025 or 2026; I just know where the destination point is. We're going back to the pre-Covid environment, which was 1.75% on the funds rate. We are going to be in for a steady diet of rate cuts through the end of next year and the end point will be 1.75.

Read: Fed starts rate-cutting cycle with a bang - but wants it to be the only one

MarketWatch: You've been a vocal critic of this Fed having been behind the curve on inflation. Do you see Powell & Co. now learning from their mistake?

Rosenberg: The Fed historically moves incrementally. It's a slow moving machine. When it moves 50 basis points, it's seeing something a lot of us don't. People should ask why would they cut rates 50 basis points? This is the same Fed that fell way behind the inflation curve in 2021 and now has moved in the other direction.

The Fed fell behind the inflation curve, and now they've moved in the same direction the other way on the growth curve. They said "Don't worry about inflation." Oops! Now they're saying "Don't worry about the economy." Next year they'll be saying "oops" once again. The Fed makes mistakes in both directions, and that has been true since it as created more than a century ago. If the Fed was perfect we would never have recessions.

The one thing Powell said that was accurate was that the data and the evolution of the economy will guide where monetary policy is going. The same data and evolution that brought them to this 50 basis point cut will take the fed funds rate down to 1.75% by this time next year.

More: This unemployment measure you've never heard of is flashing a recession warning

Plus: A Fed rate cut with the stock market at a record high? Here's what history says.

-Jonathan Burton

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09-21-24 1037ET

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