When the Fed cut rates on Wednesday, it was giving investors what they wanted—or at least that’s what they thought. The FOMC made the decision to make a 25-basis point cut to the target Fed Funds rate and that was the first rate cut since 2008. The initial reaction was rather muted as investors had already priced in the rate cut. However, when Chairman Powell started answering questions at the press conference afterwards, investors got spooked.
I think investors got spooked for two reasons. First, Powell indicated that there wasn’t a plan for a series of cuts at this time. Secondly, the chairman sent some mixed messages and wasn’t very clear in his communication with the press. The market dropped sharply after the press conference, but it has jumped sharply on Thursday morning and has pretty much erased the post-announcement selloff.
One of the more interesting things I kept hearing about the cut was that it was a “hawkish cut”. I found that to be funny because the last hike in December was described as a “dovish hike”. The statements after each of the meetings ran counter to the actual actions, hiking is hawkish and cutting is dovish.
Personally I agreed with the hike in December, but don’t agree with the cut the Fed made yesterday. The cut was made for the wrong reasons. It was made to appease investors and President Trump.
The dual mandate given to the Fed by Congress is to keep prices stable and employment high. Right now the Fed is accomplishing both of those things and they are doing them really well. The unemployment rate has been bouncing around the 3.6% to 3.7% for the last few months and that is the lowest it has been since the early ‘70s.
The inflation rate is hovering just under 2% and has been at or under that mark for all of 2019. Our GDP growth rate is at 2.1% and is higher than the inflation rate which is what you really want to see.
So why does everyone think the Fed should be lowering rates? Because many central banks have been cutting rates and several countries have negative interest rates. The European Central bank’s rate that is equivalent to the Fed Funds rate is at -0.6%. The EU’s GDP growth rate is a whopping 0.1%. Obviously the EU needs the low rates to keep their economy from going in to a recession—or at least they are trying to keep from going in to a recession.
Switzerland’s interest rate is at -0.75% and the GDP growth rate is at 0.6%. Denmark’s interest rate is at -0.65% and the GDP growth rate is at 0.1%. Sweden’s interest rate is at -0.25% and the GDP growth rate is -0.1%.
Are these really the countries we want to keep up with? Do we really want to cut our interest rates in order to keep up with what these countries are doing? I don’t think so.
Protect the Downside and the Upside Will Take Care of Itself
President Trump has been very critical of Chairman Powell and the Fed. He has been calling for a rate cut for quite some time. Obviously the president wants to see the economy growing at a faster pace and wants to get reelected, but it isn’t the job of the Fed.
To me it seems like President Trump is talking out both sides of his mouth. On the one hand he boasts about the employment numbers and the unemployment rate and then turns around and chastises the Fed. That doesn’t make sense. As the president, it seems to me that you want the economy growing and unemployment low enough that the Fed doesn’t see the need to cut rates.
Something that I thought about last night after reading some tweets from President Trump was some thoughts from his own book. I read Trump: The Art of the Deal back in the late 80’s and there were some ideas that stayed with me all this time. One particular concept was, “Protect the Downside and the Upside Will Take Care of Itself”. That was from Chapter Two in the book when he talked about elements of the deal. It seems to me that the Fed is doing just that—protecting the downside.
The Fed is trying to keep rates at the current level so that they have as much ammunition as they can if we start seeing the economy slide. Making a rate cut when the economy is growing at over 2% doesn’t make much sense.
I pulled out my copy of The Art of the Deal this morning to make sure I got the wording right on “Protect the Downside and the Upside Will Take Care of Itself”. When I did, I couldn’t help but notice the sub-head on the opposite page—Maximize Your Options. This also jumped out at me because it seems like that is what the Fed is trying to do. They are trying to keep their options open when it comes to interest rates.
I applaud Chairman Powell for resisting the temptations to act on interest rates until now. I still think they shouldn’t have cut rates with the employment numbers being as strong as they are, but had the Fed not acted on Wednesday, the market would have been shocked and we would have seen a huge selloff—maybe one of the biggest ones in history from a points standpoint. The Fed got backed in to a corner on this one. Hopefully they won’t get backed in to a corner going forward. Don’t cave to the pressure from investors or the president.
The Fed continues to state that it is data driven and it needs to keep it that way.