The Federal Reserve cut interest rates last month for the first time since the Great Recession of 2008. Financial markets bounced on anticipation of Fed intervention. President Trump also lobbied for lower rates, and he was loud about it:
The rate cut came as no surprise; it was just a matter of how steep a cut would be. After cutting rates, Federal Reserve Chairman Jerome Powell spoke to the press. His tete-a-tete with Michael McKee made Powell appear dazed and confused:
Michael McKee: There’s a perception out there that perhaps in this case the Fed is something of a hammer in search of a nail. Because of the latest consumer spending reports as you suggested, don’t seem to show any kind of demand problem in the US. And when you look at mortgage rates, auto lending rates, they’ve all come down and so wondering exactly what problem lower capital costs will solve ...
But the followup question is how does it do that? How does cutting interest rates lower or how does cutting interest rates keep that going since the cost of capital doesn’t seem to be the issue here?
Jerome Powell: I really think it doesn’t. I think the evidence of my eyes tells me that our policy does support, it supports confidence, it supports economic activity, household and business confidence and through channels that we understand. So it will lower borrowing costs, and it will work. And I think you see it since we noted our vigilance about the situation in June, you saw financial conditions move up and you saw, I won’t take credit for the whole recovery, but you saw financial conditions move up, you see confidence which had troughed in June, you saw it move back up. You see economic activity on a healthy basis. It seems to work through confidence channels as well as the mechanical channels that you are talking about.
The Fed has been monitoring weakening global growth and weak manufacturing. Powell made it appear as if cutting interest rates would help spur global growth or manufacturing activity. If low rates are reverberating through the economy, then what impact would cutting the fed funds rate have? Powell's response that "supports confidence, it supports economic activity, household and business confidence" sounded confusing.
The Fed had vowed to be data-dependent. However, Powell's response sounded emotional, rather than one based on research or data. It begged the question, "Does Powell something about the economy the rest of us do not?" The rate cut came shortly after the Fed hiked rates in December. In my opinion, Powell never gave a clear explanation as to why he was cutting rates.
Growth in personal consumption expenditures ("PCE") ex-food and energy had not reached the Fed's 2.0% target for most of 2019; it stood at 1.6% in May. However, unemployment for June was extremely low at 3.7% and wage growth was a solid 3.2%. The employment picture did not seem to justify a rate cut. The action seemed as an attempt to counteract the negative impact of the trade war with China, which President Trump instigated. It may have also been an attempt to appease the president. Either way, the move seemed more political than rooted in economics.
Interest Rates Are Extremely Low
Interest rates are extremely low. The 10-year treasury yield is currently at 1.75%. This is 119 basis points less than the 2.94% 10-year treasuries traded at in August 2018; it is also 94 basis points lower versus December 31, 2018.
Such low rates should be considered a good thing. They drive down rates for mortgages and autos and should be considered stimulative. Jerome Powell still has not explained how such low treasury yields are or are not helping the economy. Secondly, if rates have fallen by 94 basis points since the Fed's last rate cut then what would another rate cut accomplish?
Is Helping Stocks Helping The Economy?
There is an adage, "When all you have is a hammer, everything looks like a nail." When the only tools the Fed has are rate cuts, then every problem is apparently solved by rate cuts. I doubt more rate cuts will aid the economy. But they could provide a buffer for stocks. The majority of equities are controlled by a small percentage of the population. Continuing to spike financial markets could lead to cash hoarding by those enjoying such stock market gains.
Over the past decade, the Federal Reserve has tried to create a wealth effect by spiking asset prices. At the end of 2018, U.S. non-financial companies were holding $1.69 trillion in cash. That was down from $1.99 trillion at the end of 2017. We may need to find a way to entice these institutions to spend this cash or set policy to put cash in the hands of people who will spend it. This would require fiscal policy to kick in now that monetary policy appears to have run its course.
In my opinion, Jerome Powell did not give cogent answers pursuant to how rate cuts would spur the economy. After a decade of money-printing, monetary policy has likely run its course. Investors should avoid cyclical names and highly-indebted companies that need consistent cash flow to service debt.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.