On July 31 st everyone expects the Fed to lower the fed fund target rate 25 bps. We, and many others, believe rate cuts can keep this slow and weak economic recovery alive for a little while longer. And the Fed is not only the only central bank talking about cutting rates. Even the European Central Bank last week was talking up rate cuts or further stimulus to boost their economy, inflation, employment and stability.
But how necessary are rate cuts and how much will they help? Let’s start with the arguments for rate cuts.
Is the economy wobbly? Last week the IMF came out with their latest “World Economic Outlook Report”. Growth was revised down citing tariffs, supply chain interruptions, Brexit uncertainties and rising geopolitical tensions. Advanced economies came in the weakest with anticipated growth of 1.9% in 2019 slowing to 1.7% in 2020. The IMF also notes risks are to the downside. Additionally, last week US 2Q GDP came in at 2.1%, which was slower than last year but above consensus. Slowness is not a disaster, but the Fed can likely check the wobbly box.
Is inflation meeting target? In the US Personal Consumption Expenditures recently faded to 1.6%, below the 2.0% Fed target. It is clear the Fed targets are not being met and they are more afraid of deflation than inflation. So, check this box.
Is unemployment too high? Hard to see how the Fed can check this box. US unemployment is at a 50-year low and income for the lowest wage earners are rising faster than overall wage growth.
What about financial stability? One can argue this point, but we see equity markets reaching new highs, capital markets are wide open to all types of companies, consumer credit is available and banks ready to lend. This looks solid. Negative factors include higher levels of volatility and policy risk which are hard to ignore. But on average it is difficult to check this box at the moment.
The next question is: how long can the Fed extend this economic expansion?
We do not believe the Fed has the ability to abolish recessions. Yet we also believe it is hard to have a recession when the Fed (and all other central banks) is very accommodating. The next recession will eventually come and could be caused by any number of policy mistakes or geopolitical shocks. When it does happen we are concerned the Fed will have exhausted its rate cutting and stimulus options by keeping this expansion alive.
We may yet check that box, but not today.Related: Wildfire Liability and California Credit Sources: Bloomberg, The Financial Times, BCA, The Wall Street Journal