- The market took Powell’s comments to the bank, literally.
- The NY Fed walks back expectations of rate cuts in July.
- I point out that interests between the markets and Fed have somewhat diverged, with the Fed taking a longer view based upon their data.
- The Fed knows it needs to save its bullets for the recession, where the IMF has already warned most central banks may be armed with only partially loaded weapons.
Money often costs too much. –Ralph Waldo Emerson
Here Come the Money Addicts
The stock marked has been jubilant over the expectation that the Fed is going to cut rates at the end of this month at their FOMC meeting. This based on Fed Chairman Powell’s recent comments to Congress that inflation is weak and that the Fed would act “as appropriate” to keep the recovery going.
Powell stated his views on trade tensions, the global economy, and inflation.
Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.
Powell did not feel as though a strong jobs report would influence his decision, describing the jobs market as not hot. He also spoke positively about the resumption of trade talks between the US and China, though those talks haven’t really progressed since.
Analysts View on Rate Cut Almost Arrogantly Confident
Analysts have widely interpreted these remarks as foreshadowing a rate cut. In the above video from CNBC, analysts have come to the conclusion that the Fed will cut interest rates this month based upon Powell’s comments. Their only question is whether the cut will kickoff a new string of easing operations by the Fed.
The purpose of the discussion is transparently discussed at the end, which is to assure markets that money will be available when they need it. To keep the market rally going, financial liquidity is king. Once that spigot is turned off, and traders realize the sheer size of corporate debt, doubts about further expansion will begin to take hold and markets would very likely fall.
Other analysts joined the celebration of easy money policy. Ralph Axel, senior U.S. rate strategist at Bank of America Merrill Lynch, has this to say.
He’s explaining why he thinks it’s appropriate to cut rates. I think really the question for markets is — is it 25 or 50 (basis points). This has pushed us closer to 50. I think 50 would be more effective.
The market is pricing in the rate cuts as if they have been made official, as further evidenced by Axel’s comments.
The fed funds futures market has been pricing in a 25 basis point, or quarter-percentage point cut to the fed funds target rate range, now at 2.25 to 2.50%. Axel said the market began to price a 58% chance of a 50 basis point cut, after Powell’s prepared comments were released at 8:30 a.m. ET. The market is pricing in 68 basis points of easing by the end of the year.
Other market analysts had similar views on Powell’s speech. Peter Boockvar, Chief Investment Officer at Bleakley Advisory Group, offer this statement.
Bottom line, Jay Powell fully endorsed the July rate cut and did absolutely nothing to pull the markets back from that expectation. There was little in the statement to imply what this means past the July meeting but we can infer that any further softening in the data past July will likely mean more action from the Fed at subsequent meetings.
Carl Riccadonna, Yelena Shulyatyeva and Eliza Winger from Bloomberg Economics interpreted the testimony as admitting to the previous follies of Fed decisions.
Powell chose not to reshape market expectations, which were leaning heavily toward a July cut of 25 bps, further illustrating that the Fed is not willing to fight market sentiment following the clumsy execution of its final rate hike in the fourth quarter of last year.
The Market is Calling For Resumption of Permanent QE
Market analysts are clearly expecting the resumption of more permanent quantitative easing operations from the Fed. In fact they are stumping like politicians for permanent resumption of easy credit. The Q4 2018 correction in the major stock indices clearly scared analysts to the realities of what a very modest tightening policy could look like.
Further, the inversion of many US bond rate pairs this year, which typically predict an oncoming recession within 6-18 months, may have sobered a previously sanguine market on the potential realities of a slowing economy on the debt markets. The market doesn’t want to accept the possibility of a deflationary recession right now. Whether or not we get there; however, may beyond the power of the Fed to control regardless of what short term policy decisions they make.
Once the Fed goes back to easing, it can never stop. We already know what happens when they do as evidenced by how markets finished 2018. The Fed absolutely needs to maintain room for interest rate cuts during the next recession. The IMF has warned that almost all countries lack the room to fight off recessionary pressures using interest rate policy.
Source: Gold Silver Pros, IMF
What happens if Powell gives the market what it wants, and how long does that extend this bull market? Eventually all markets turn down as all economies go into recession. We are currently in a very mature bull market, and it is unlikely that firing the last Fed bullets of monetary easing are going to by us another 10 years. Eventually, the market always overtakes official monetary policy.
Source: CNN Business
NY Fed Resets Expectations
New York Federal Reserve President John Williams just warned the market not to take Powell’s comments too literally. Indeed, Powell was speaking from an academic perspective and not a policy one, according to a spokesperson for the NY Fed.
This was an academic speech on 20 years of research. It was not about potential policy actions at the upcoming FOMC meeting.
We could have one of two things happening here. Perhaps the Fed did not expect, nor realize, how deeply the markets need the Fed to ease. With such a strong reaction, perhaps the Fed felt the need to reset expectations for the near term. My personal response to Powell’s testimony was more mixed, as it seemed Powell was speaking more about longer term economic factors that may influence Fed decisions with monetary policy. I believe the Fed was astonished at how analysts interpreted the comments.
Perhaps Powell’s comments were dovish on purpose in order to ease market concerns ahead of the July FOMC meeting. Perhaps the Fed knows it is walking a tightrope with a slowing world economy.
Something Powell said may provide a clue to the Fed’s collective thinking beyond the US economy, and about much more than the next fiscal quarter.
“Momentum appears to have slowed in some major foreign economies,” he said, and the weakness could spread to impact a U.S. economy that’s currently on a “solid footing.”
Further, the Fed is currently split on whether to continue easing due to concerns that uncertainty could continue, per Bloomberg. The overall calculus is that things could get worse, and no action need be taken now until things progress [emphasis mine].
The 17-member Fed policymaking committee was split in June over whether the central bank should cut rates this year, with eight officials projecting a cut before the end of the year and nine pointing to no change or a rate increase. Minutes from the June meeting that were released on Wednesday reinforced Mr. Powell’s message. Many Fed officials thought a rate cut could be warranted “in the near term” if uncertainty persisted, the notes show.
It appears the Fed is on the same wavelength as the IMF that saving its interest rate ammo will be critical to deal with a slowing world economy that will eventually make it to US shores. Remember, the Fed is still running off their balance sheet through September, a fact all but ignored by US financial media.
What Happens Next?
I suggest that the Fed stays the course with interest rates at least until September. At that time, their current program of selling treasuries will end and they can align their balance sheet and interest rate policies. Cutting interest rates now would seem to counter the balance sheet strategy and reduce its effectiveness by flooding the market with more new debt issuance.
After all, the stock markets have recently reach all-time highs. Given the Fed believes that the US has not yet followed the rest of the world into recession gives me the impression they aren’t willing to pull the trigger on rate cuts yet.
This could change, of course, should something break in the banking sector and cause a potential liquidity crisis like we saw in 2008-9. There have been signs of banking sector weakness in Europe and China, but no formal signs yet that debt market contagion has reached the US banking system.
The next few months will invariably have market analysts on pins and needles. They need easy money to keep stock markets ebullient and handy cheap cash to roll over record levels of corporate debt. The Fed has bigger concerns looming on the horizon and therefore may not appease the market by cutting rates before the next recession officially begins.
However, if they choose to resume QE, then it will be the beginning of the end for the stability of the monetary system. They will not be able to stop the program without contracting the markets, so they would keep the easy money flowing. And it would basically guarantee negative interest rate policy in the US in order to have enough room to deal with recessions.