Investors are in a buying mood despite many economic warning signs. Why?
For some, it’s because they expect the Federal Reserve to cut interest rates and otherwise “stimulate” the economy. They believe (correctly) it would drive stock and real estate prices higher.
At the risk of stating the obvious… higher asset prices mainly benefit those who own the assets. Which, in the stock market’s case, is not most Americans.
The ordinary worker’s main asset is the income stream from their job. Lower interest rates don’t necessarily help them.
Nonetheless, that seems to be what the Fed will give us, if President Trump gets his way.
The Federal Funds rate, the Fed’s overnight benchmark, is historically low right now. But with zero rates now a more recent memory than 5% rates, it seems high to many folks. President Trump is one of them.
The weird part is that Trump appointed most of the Fed governors whom he now calls incompetent. If he wanted doves, many were available. He didn’t pick them and now blames everyone but himself for the results.
But set that aside. Fed chair Jerome Powell says they respond to data, not presidential jawboning.
I used to think that was true. Now, I’m not so sure.
Amid the drip-drip-drip, it’s easy to lose sight of the timeline. Bloomberg has a handy digest of Trump’s Federal Reserve comments. His first hit was almost a year ago: July 19, 2018.
“I’m not thrilled” the central bank is raising borrowing costs and potentially slowing the economy, [Trump said] in an interview with CNBC. “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”
It got worse from there, but the Fed seemed unperturbed. Powell and the FOMC kept raising rates and markets dropped last fall. After the December rate hike and some especially hawkish Powell comments, Trump reportedly discussed firing Powell.
(I reported months earlier that Trump appeared to have that power, though I didn’t predict he would use it.)
Anyway, six weeks after the December rate hike, the Fed made a remarkably convenient reversal. The committee was suddenly sure rates were high enough.
Was it coincidence the Fed changed course right after Trump raised the pressure? Maybe. But other things were happening behind the scenes.
Here’s a little-known fact for you. The Fed chair’s daily calendar is public record. You can see it on the Federal Reserve website after a two-month delay.
Powell’s schedule is pretty boring: mostly meetings and phone calls with Fed officials and other central bankers.
Last January—between those two FOMC meetings in which the Fed changed its mind—Powell had several contacts with Treasury Secretary Steven Mnuchin.
He also met White House economic advisor Larry Kudlow, as well as Goldman Sachs (GS) CEO David Solomon and several members of Congress.
Those aren’t necessarily unusual. Look at other months and you’ll see Powell and Mnuchin talk frequently. About what? We don’t know.
Still, high officials have busy schedules. These probably weren’t social calls. Maybe somebody delivered Powell a, ahem, “message.”
On February 4, Powell had a private dinner with Secretary Mnuchin and President Trump. Then the next day a meeting with Senate Majority Leader Mitch McConnell.
Possibly this was all normal business… but given that period’s pivotal events, it’s fair to wonder.
And it’s a fact that since then, the Fed has avoided raising rates, just as Trump wanted. It hasn’t cut rates (yet) and may not. And Trump is still making threats.
So one interpretation is that Powell tried to mollify Trump by meeting him halfway, but Trump isn’t satisfied. He clearly wants lower rates, not just stability.
What if he gets them?
Path to Japan
This used to be pretty simple. When the economy slowed, the Fed would cut rates. This encouraged borrowing and investment. People bought houses. Businesses expanded and hired people. The economy would recover.
Now, it doesn’t seem to work that way. My friend Peter Boockvar succinctly explained why in one of his recent letters. The problem is that “easy money” stops working when it becomes normal, as it now is.
“[When easy money is] a permanent state of being, it doesn’t incentivize any new economic behavior to happen today instead of tomorrow.”
Bingo. Lower rates don’t encourage borrowing unless potential borrowers think it’s a limited-time opportunity. Which they don’t anymore, and shouldn’t, since the Fed shows no sign of ever going back to what was once normal.
That’s not just me. The FOMC’s own projections show they think 2.5% is now the “longer run” normal. Even the most hawkish foresee only 3.3%.
When this is also the president’s stated desire, it is very hard to foresee the Fed raising rates significantly higher than they are now. Hence, rate cuts probably won’t do much to stimulate the economy.
Nonetheless, lower rates from here would have effects. They would…
- Inflate stock and real estate prices even more,
- Cut returns for retirees and small savers, and
- Reduce the federal government’s borrowing costs.
That last point may be significant. As John Mauldin showed last weekend, there is simply no way to balance the budget with interest rates where they are now. Maybe that is Trump’s concern.
Or maybe not. Lower rates would also help, say, highly leveraged real estate developers.
What rate cuts won’t do, in my opinion, is prevent or even mitigate the next recession. More likely, they will push the US further down the same path Japan is now on: decades of slow growth, enormous debt, and social stress.
That’s the best case. The worst one?
You don’t want to think about it.