Federal Reserve rate cut will boost stocks: strategist

David Dietze, Senior Investment Strategist at Peapack Private Wealth Management, spoke with Quartz for the latest installment in our “Smart Investing” video series.

Watch the interview above and check out the transcript below. The transcript of this conversation has been lightly edited for length and clarity.

ANDY MILLS (AM): The FOMC meeting is underway. How big do you expect this first class discount to be?

DAVID DIETZE (DD): No one really knows now. Fed futures suggest a slight favoring of a 50 basis point cut over a 25 basis point cut. But there’s such a wide spread of opinion, and that makes this Federal Reserve meeting actually very historic because it’s been decades since we went into a meeting with so much uncertainty about what will come out of it. Members of the Federal Reserve typically prepare the investing public for what to expect by the way they frame their remarks at various press conferences and so on. At the moment they were all over the front. So it will be very interesting.

AM: 50 basis points seems drastic, although we haven’t done anything like that since the financial crisis.

DD: I think the argument for doing 50 basis points is that we’ve seen a tremendous reduction in inflation over the last, let’s say 24 months. So right now, inflation is probably running at about 2.5% a year. While your fed funds futures are close to 5.5%, the 3% difference is huge. Most people think it should be at least 1% lower. And so the question is, do you take baby steps to get there, or do you start with a bang and move quickly? I think the reason for taking more measured baby steps is because we could see yet another burst of inflation. We have seen that the economy is quite resilient here. We still have a four handle on unemployment. I think the reason to go big here is because we’re starting to see those unemployment numbers go up. We were at about 3.5% unemployment. We got to 4.3, now we’re at 4.2. Many economists say that once it makes a half-point move, it tends to get big and try to outpace a slowdown, which would unnecessarily hurt so many people in the workforce because your monetary policy is so unnecessarily restrictive.

AM: Do you think investors should be hoping for a big 50 basis point move like this?

DD: I think in general, the lower the interest rates, the better for investors. That raises the present value of everything. This reduces costs for corporate CapEx expenses. It lowers the cost of big ticket items like automobiles and mortgages, of course for individuals and of course for investors. People like me advise my clients every day we look at, well, if we put our money in bonds, what are we going to get? What is the interest rate? If we invest our money in stocks, what will we get? As bond yields fall in equilibrium, it tilts the supply toward stocks, causing people to move into stocks, which pushes stock prices higher. That’s good. For investors,

AM: That’s a shift that we’re seeing where we’re now starting a rate cut cycle. What do you expect the further rate cuts to be after this and also when they will happen?

DD: Absolute. I think the Fed Fund futures are seeing 1% of cuts through the end of the year. We’ll know a lot more after Wednesday because they’ll have what’s called the dot plot, which shows what the consensus is for each meeting as to what the federal funds rates will end up being. I think we’ll probably see interest rate cuts by next summer, which could lead to a potential three-hander on Fed Fund futures. But I think the expectation now is that we have three more dates. We will have one hundred basis points, which suggests that a meeting needs to be 50 basis points to reach the 1% goal.

AM: How would the market react to a 25 basis point cut versus a 50 basis point cut?

DD: The best guess is that the market would pull back, there would be a sell on the news phenomenon. Why? Because many people, at least half of people, maybe more, are hoping for a bigger discount. And so the Federal Reserve is keeping monetary policy tighter than it should be unnecessarily. And so people sell stocks. Remember we are near all time highs. The Dow set a record yesterday. The S&P is just 70 basis points from an all-time high. So there’s not much of a cushion in terms of ratings for any kind of disappointment. Now, if there’s a 50 basis point cut, which is what happens, I think generally the market goes up because that lower interest rate force in the economy makes stocks look more attractive on the margin. Now, the counter argument is why does he have to make that 50 basis point cut? Is there something about the economy that we don’t know about that is causing them to bring out the heavy artillery to start fixing the economy? They have advanced word about deterioration in certain areas of the labor market or economy or overseas that we don’t yet know about, and so we should be suspicious of their motivation. Now in balance? I prefer to take good news with good news in terms of lower interest rates. We have seen time and time again that the Federal Reserve often has no more of a crystal ball than the rest of us. And so for them, for people to think it’s some kind of conspiracy that they know something that we don’t, I’d bet against it. But some people will say that.

AM: So if they cut 50 basis points, what do you think they know that we don’t? What is your hypothesis about the suspicious thing inside the economy?

DD: Well, he might have sure, inside, some kind of feeling that layoffs are comingthat especially low-income consumers struggle more than is generally known with car payments in terms of being able to pay their rent. They may have an advanced word about some large corporations preparing for layoffs, which will be very negative. Or it could be something overseas. Maybe they have some inside knowledge about it what is happening in china. Remember that one of the headwinds for the markets in the economy here is that the second largest economy, China, is back on its heels. We don’t know how bad it will be. We know the Chinese government wants to do something, but they haven’t brought out the heavy artillery themselves. They have some big problems in their property sector if there are defaults there. How might this spread to the rest of the global economy, including the United States? It might make more sense in that regard than Wall Street generally does.