Jun 10, 2019

Why the market shouldn't be excited about Fed rate cuts

Dion Rabouin, author of Markets

Illustration: Aïda Amer/Axios

When Fed chair Jerome Powell said Tuesday that the Fed would "act as appropriate to sustain the expansion" traders took it as the latest confirmation of the Powell put — the notion that Powell and the Fed are prepared to lower interest rates and stimulate the economy if stock prices fall too far.

Between the lines: In a strong economy like we've got now a few interest rate cuts are likely enough to keep confidence high and business activity chugging. But Friday's jobs numbers, coupled with last week's PMI readings show that things may be starting to turn.

  • Add to that the growing likelihood of recessions in Europe and Japan and the fact that policymakers there have little ammo left to fight one.
  • And U.S. interest rates are barely above the rate of inflation.

This could be a problem that 50 basis points of interest rate cuts (or even 75) isn't going to solve.

What they're saying: "The market overestimates the power of central banks and stimulus," Zhiwei Ren, managing director and portfolio manager at Penn Mutual, told Axios in March.

The problem with the economy today isn't on the supply side, Ren said. The market isn't lacking liquidity and businesses broadly aren't having trouble obtaining credit — those are the issues monetary policy is designed to tackle. The problem today is on the demand side.

  • Central banks "can pump as much money as they want but liquidity isn't flowing into the real economy," Ren added. "No matter how much credit you provide, if nobody comes to borrow that's a liquidity trap."

On the positive side: The U.S. has at least built in some breathing room by raising rates from zero, beginning in 2015, and reducing the value of the Fed's bond holdings from a record $4.5 trillion.

But, but, but: The Fed continues to purchase trillions in U.S. Treasuries and mortgage-backed securities.

  • And while the impact of the Trump tax cut and spending increases is expected to fade this year, the U.S. government is still taking in far less revenue and spending far more than it historically has — another form of stimulus the market is already receiving.

The bottom line: We're in year 11 of the monetary easing experiment and it's become pretty clear the goal of weaning the economy off its free money medicine isn't working as planned.

  • One has to wonder if a Powell put is really something the market should be excited about.

Our thought bubble, from Axios' business managing editor Jennifer Kingson: "It's interesting that the markets all move with Pavlovian predictability in response to these various indicators, when there's no longer such strong evidence that cause leads to effect the way it once did, or, at least, the way it was once seen to have done. And the power of the levers Powell wields would seem to be quite depleted."

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