Fed Follows the Script Exactly, Markets Disappointed
The Fed announced its decision and outlook on interest rates Wednesday afternoon, and we got exactly what was alluded to. Some wished for more and were left disappointed.
We would think it quite normal that people on the street might not understand the actions of the Federal Reserve Open Market Committee very well, perhaps thinking that their goal is just to boost the stock market or even the economy in pursuit of prosperity.
Even President Trump is among this group it seems, as he has been clamoring for the Fed to use their power to drive things up more for quite a while now, even suggesting that his opinion on the matter might mean something.
President Trump would, of course, like to see the economy grow more and the stock market rise more, as he could then claim the credit, as he attempts to claim the credit for just about anything positive that has happened during his presidency, whether he has had much or anything to do with it.
While we would think that the President of the United States would be more familiar with the task of the central bank of the United States, or realize that they are not subject to influence from anyone in government, including him. Even if these remarks were indeed disingenuous and just a political ploy, surely he was not naïve enough to think that his opinion mattered here, or was he?
There are some pretty big gray areas when it comes to the use of the executive power of the presidency, for instance with things like whether he can declare a national emergency and try to circumvent Congress on spending on his wall, but this one is purely black and white and there is no room for doubt.
He and many others have looked upon the state of the economy and wished that the Fed would do a better job of getting things back to where they were just a year ago, because we have indeed seen a slowdown since.
What they don’t seem to realize is that this level of growth that they long for again was a red flag for the Fed and they spent 2018 trying to cool the economy down and reduce growth, right up until their last rate hike of the year in December. Just before this last rate hike, the word was that they will have to pour more water on it, but we ended up seeing growth decline enough to satisfy them for now and they told us they would be standing pat for now rather than putting the rate up even more.
The Fed Sets the Bar Lower Than Most Think
Any thoughts of the Fed wanting to get back to 3% GDP growth rate and doing more to get there was very confused. This is the last thing they want to see right now, as badly as others might want it. They will not be doing further cuts to get there or even get back on the path to there.
During the June meeting, the committee told us that they still had not seen enough yet to put their foot on the gas a little, although there were some things that they were watching and if they did see enough, they would act. As it turns out, things did deteriorate a little and Chairman Powell told us that they now are strongly considering a rate cut to address these concerns.
The risk of an uncomfortable decline was still expressed as fairly minor, and this move, which was well telegraphed during that time, was portrayed as an ounce of prevention, not a pound of cure, as the need here was more preventative than anything. The economy is still humming along nicely even though a small drop in manufacturing plus a further risk from the current trade dispute with China was seen to be worth spending this ounce, a quarter point drop.
This message was all pretty clear and it did not take any expertise at all to interpret it, as anyone should be able to understand that we don’t need to do much here and all that is warranted is doing a little.
The investment world does rely on hope a lot, and it’s not that unusual for people to do a lot more hoping than they should even though it may not even be reasonable to do so. Thinking that we’d get a half-point cut this time around wasn’t reasonable at all and you perhaps could have bet your life on this and not had the need to worry too much about losing it.
There was never any indication that such a move was even being considered at all, and when you have the only person who voted for a rate cut in June telling us a half point is too much, there isn’t even anyone on this side, and it takes a majority.
Thinking that we’ll get one cut this time and the plan is to do more later in the year was also purely contrived, as this did not match up with any of the messages we were getting. The Fed isn’t given over to drama and they actually do try to be as transparent as they can without telling us right out what will happen at a meeting in the future, as these things do need to be voted on and things can change even in a week or two, but they do let us know where they are leaning.
Everything Went Off Exactly as Expected
This time the result came in exactly as they told us it would, with the quarter point that was very strongly suggested, although two members voted to keep things unchanged. There was also no grand plan to do more, and they did tell us that this would be a pre-emptive strike and we didn’t really need much here to make sure the ship was on course.
We have been hearing things like the market pricing in a bigger cut and more cuts this year, although it’s never been clear where these ideas were supposed to come from other than perhaps thinking that was so wishful that it caused us to close our eyes.
Things can change of course, and it’s still possible that things will decline enough later this year to cause the Fed to do another cut, but that wasn’t on the horizon during the June meeting, during Powell’s report to Congress, nor in this week’s meeting. Pricing in more than this would require that we bet on things worsening quite a bit, and this bet lost on Wednesday.
Powell called this move a “mid-course correction,” and that is a great way to put it and should actually inspire confidence rather than disappoint. This suggests that the Fed sees our current cycle as having a lot more life left in it, if it has been going on for 10 years already and we’re “mid-course” in any meaningful way.
Growth during this time has actually been fairly modest all along, with the usual ebbs and flows that are inevitable, but the management of it has been quite exemplary. We might even want to say that a new day has dawned upon the Fed where they are in an economic environment that is stable enough that they can do a fabulous job of smoothing the business and economic cycle, and smooth and modest are the ultimate goals here.
As expected, the Fed also choose to end shrinking its balance sheet now instead of waiting, and shrinking the balance sheet goes against the mildly expansionary effect of a rate cut like this. These are the two tools of the Fed, monetary policy and interest rate policy, and they just turned both green if expansion and stimulation is what you consider green.
Stock markets sold off on the news of course, but that’s also something we could have also easily predicted, and the program trading was set to sell on a quarter point and that’s exactly what happened. Program trading does generate a lot of market noise and when this is set to sell mode, we see markets go down until they are finished at least.
The first move we saw was computers being disappointed, but then we had humans join in on this, the ones that are timing their positions such that this sort of thing really matters to them. The markets being down 1.5% intraday isn’t something that investors will care about much, and certainly not enough to see them sell, but they sit on the sidelines in this game.
We did get a second wave which was looking for a bounce, and for a time we did get that, but the overall dim mood took back over and we ended the day almost as low as the computers took us initially.
This is not bad news at all for stocks, as we did get what we wanted and whether we even needed this is an open question. There was a big fear that disappointing earnings this time around might take us down quite a bit, but three quarters of the stocks in the S&P 500 exceeded expectations, which is actually quite encouraging at any time.
Index levels took a bit of a sting regardless, and added to a modest downtrend on the daily charts, but we’re still way above where we were at the start of June, before all this excitement about rate cuts propped the market up. We’ve given up 500 Dow points since the peak of this enthusiasm, but this still leaves us with a net gain of about 1300 more, and the actual word is out now instead of our just speculating on it.
We might even want to say that while we overshot things by pricing in too much good news, the news we did get was good enough to leave us up quite a bit in the end.
While we haven’t seen much market time since the decision and outlook, at the close of trading Wednesday, it is in the early hours that we’re the most prone to over-react, so only dropping this much bodes well, even though it wouldn’t be reasonable to expect much more than this.
The real reason why the old adage of sell on the news does have any merit is that we often will expect better news than we get and this is a perfect case of that. Those who might have thought that the Fed is all that concerned about things just haven’t been paying attention much, but a lot of people don’t it seems.
Editor, MarketReview.com
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