Weekly Economic Release Summary: Cutting The Federal Funds Rate Will Not Prevent A Recession

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by: Steven Hansen
Summary

There are many reasons that the historically low federal funds rate cannot be decreased enough to prevent a recession.

Many interest rates do not follow the federal funds direction.

And a review of the data is not indicating a recession is in sight.

The FOMC said in their meeting minutes released this past week:

Among those participants who commented on financial stability, most highlighted recent credit market developments, the elevated valuations in some asset markets, and the high level of nonfinancial corporate indebtedness. Several participants noted that high levels of corporate debt and leveraged lending posed some risks to the outlook.

According to economic theory, a lower federal funds rate leads to lower borrowing costs for business and consumers. Then, in theory, business and consumers would borrow more money which in turn would be spent spurring the economy. In practice during the last 20 years, it is only some consumer borrowing which follows the trend lines of the federal funds rate. Additionally, IF corporate debt is already too high - how would a lower interest rate help corporations borrow more so they could spend more.

The problem is and continues to be that:

  • Even if the cost to borrow money is cheap - ya gotta have a need to borrow money.
  • And the lending institution needs to have a reasonable expectation that the loan will be repaid - the median consumer is likely unable to borrow more money.
  • Lower interest rates produce lower-income to lenders which tends to counter any increase in purchasing by consumers. Debt has two sides - the borrower and the lender. What is good for one is likely not good for the other.

The graph below shows consumer credit outstanding (this data series does not include mortgages) is now above a high of over 26% of consumer spending in the 2000s, and well above the averages before the mid 1990s.

The Ratio of Total Consumer Loans Outstanding to Consumer Spending

My Bottom Line

For the last three years, consumer borrowing growth has been fairly constant - even though interest rates for consumer loans have been historically low. In today's economy, I struggle to identify any newly developed product or service that would cause one to borrow money to purchase.

Although I fail to see how a lower federal funds rate helps the U.S. economy directly, the global economy is a different story. As the dollar is, in reality, an international currency - the federal funds rate leaks into the global economy. A lower federal funds rate improves multinational corporations bottom line and does tend to stimulate smaller economies which trade in U.S. dollars. Improved international trade would help U.S. exports PROVIDED the dollar does not strengthen.

Lowering the federal funds rate can only provide minuscule economic benefit when the rate is already historically low.

My final thought is that the economy faltered in 2015-16 (see blue line in the graph associated with our economic index below) - and a recession did not follow. At this point, the discussion of a recession is very premature.

Economic Forecast

The Econintersect Economic Index has a long term decline which began in July 2018 - this month (August 2019) our forecast marginally improved but continues to predict very little growth.

The fundamentals which lead jobs growth are now showing a slowing growth trend in the employment growth dynamics. However, we expect jobs growth over the next six months to exceed the growth needed to maintain participation rates and the employment-population ratios at the current levels.

Economic Releases This Past Week

The following table summarizes the more significant economic releases this past week. For more detailed analysis - please visit our landing page which provides links to our complete analyses.

Overall this week:

  • New and existing homes rate of growth continues to improve but still remains soft
  • Transport continues to warn of soft growth
  • The FOMC forecasts economy on a good path but lowered the federal funds rate anyway :(

Economic Release Summary For This Week

Release Potential Economic Impact Comment
July Trucking transport mirrors the economy

Headline data for the American Trucking Association (ATA) tonnage significantly improved, and the CASS Freight Index reported the year-over-year growth rate continues in contraction.

The CASS index is inclusive of rail, truck, and air shipments. The ATA truck index is inclusive of only member movements.

I tend to put a heavier weight on the CASS index which continued in contraction year-over-year. On the other hand, the ATA index significantly improved and is in expansion. The ATA index is an outlier on the positive side - and is contrary to almost every economic data point.

July Existing-Home Sales

n/a

The headline existing home sales improved relative to last month with the authors saying "Falling mortgage rates are improving housing affordability and nudging buyers into the market."

The rolling averages for existing home sales have been improving for the last 6 months. This month the rolling averages remained in contraction.

Median home prices declined this month which may have more to do with increased sales than mortgage rates.

Although this was a much better month than June, keep in mind that the rolling averages are improving but are in contraction.

July Coincident Indicators slowing economy

The year-over-year rate of growth of various coincident indices relative to the previous month slowed.

Economic indicators that coincide with economic movements are coincident indicators. Coincident indicators by definition do not provide a forward economic view. However, trends are valid until they are no longer valid, making the trend lines on the coincident indicators a forward forecasting tool.

Generally, the coincident indices are showing modest growth. Econintersect's analysis of the coincident indices is that:

  • The Philly Fed US Coincident index year-over-year rate of growth slowed - and this index is still indicating a relatively strong economy.
  • The Aruoba-Diebold-Scotti business conditions show below-average business conditions.
  • The rate of growth of the Conference Board Coincident Index slowed - and is in the low part of the range seen since the end of the Great Recession.
  • ECRI's Coincident Index's rate of growth declined - and remains below average for the values seen in the last 2 years.
  • The CFNAI rate of growth is below the historical trend rate of growth (zero-line) and is in the low part of the range seen since the end of the Great Recession.
FOMC July Meeting Minutes ????

The 31 July 2019meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members. An interesting quote:

... A couple of participants indicated that they would have preferred a 50 basis point cut in the federal funds rate at this meeting rather than a 25 basis point reduction. They favored a stronger action to better address the stubbornly low inflation rates of the past several years, recognizing that the apparent low sensitivity of inflation to levels of resource utilization meant that a notably stronger real economy might be required to speed the return of inflation to the Committee's inflation objective....

I suggest everyone read these minutes - they have not been cookies cutter minutes (having little real change between meeting) since the departure of Chair Janet Yellen.

It is interesting that the Fed when faced with lower Treasury yields, slowing inflation, great jobs growth, and belief the economy was doing well - decided to lower the federal funds rate.

The FOMC does not want to be predictable:

In their discussion of the outlook for monetary policy beyond this meeting, participants generally favored an approach in which policy would be guided by incoming information and its implications for the economic outlook and that avoided any appearance of following a preset course.

So much for the forward guidance experiment.

July Leading Indicators points to soft growth

The Conference Board Leading Economic Index (LEI) for the U.S improved this month - and the authors say "the manufacturing sector continues exhibiting signs of weakness and the yield spread was negative for a second consecutive month."

Even with this month's growth, this index remains on the low side of values seen since the Great Recession.

This index is designed to forecast the economy for six months in advance. The market (from Econoday) expected this index's month-over-month change at +0.1 % to +0.2 % (consensus +0.2 %) versus the increase of -0.5 % reported.

July New Home Sales weaker data this month but still on improvement trend line

The headlines say new home sales declined month-over-month. Median and average sales prices were little changed.

This month the backward revisions were significantly upward. This means the slowing this month was caused by the upward revision last month. Because of weather and other factors, the rolling averages are the way to view this series. The rolling averages declined.

Even with the decline this month, growth in 2019 still exceeds every year since 2007.

This data series is suffering from methodology issues which manifest as significant backward revision. Home sales, in reality, move in spurts and jumps - so this is why we view this series using a three-month rolling average.

Surveys in contraction

August Kansas City Fed Manufacturing -

Kansas City Fed manufacturing has been one of the more stable districts and their index even though below the range seen in the last 12 months. Note that the key internals were in contraction. This should be considered a worse report than last month.

Market expectations from Econoday were 2 to 5 (consensus 2). The reported value was -6. Any value below zero is in contraction.

Rail Movements Definitely not positive news

Rail so far in 2019 has changed from a reflection of a strong economic engine to contraction. Currently, not only are the economic intuitive components of rail in contraction, but the year-to-date has slipped into contraction.

My usual week wrap is in my instablog.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.