You never really know how the stock market will react to a given news item. The Federal Reserve once again declined to lower rates, but this time it was well accepted.
There has been a lot of concerns about the economy among investors and commentators, and is often the case with such things, these concerns tend to be overinflated. That’s the way it goes with concerns, fears if you will, but sometimes a little reassurance can go a long way.
There has been a real gap between some people’s concern of an impending recession or at least an economic slowdown of a clearly undesirable magnitude and the Fed’s position on this, People have been looking to the Fed, who are the guardians of such things in the United States, to step in and save them from their fears, and see that the Fed isn’t concerned and even quite happy with the way things are, and this this can cause a rift.
When we get such a rift, this is bound to affect stock markets, and concerns that affect stock prices don’t get vetted, so it doesn’t matter how reasonable or unreasonable they may be, they still exert their impact. Just like with anything else, poor thinking or emotional reactions can lead to clear actions and consequences just like wise and considered thought can.
Many people may have an idea of what the Federal Reserve Open Market committee does, but may not quite have the depth of understanding necessary. Donald Trump is certainly one of them, with his thinking that their role is to create growth or move stock prices higher, and he has made it plain that he would prefer a rate cut right now, to stimulate the economy and the stock market.
The Fed only does these things when they are really needed though, and this is not a tool to boost profits or to have people sitting with more valuable portfolios, or even to appease presidents. President Trump seems to actually believe he has some say or sway with the Fed, and has even threatened to step in if he doesn’t get his way, in spite of this being a ridiculous notion.
The president has zero influence with the Fed though, which are entirely independent of the executive branch or any branch of government. The U.S. government does appoint the board, but beyond that, they are like the judiciary, and this is where the connection ends completely.
The Fed isn’t even a branch of government per se, and answer to no one but themselves. Given their immense power, this bothers some people, but this complete independence is absolutely necessary, lest they be swayed by political influence such as Trump would prefer and be forced to act in a manner contrary to long-term national interests.
We already have way too much of this in our government, and some of it may be a necessary evil that comes along with a democratic system, but the economy is too important to be subject to whim, popularity, or misguidance. Mistakes here can be very harmful and even destroy the economy if the goal is to just promote growth and we end up with hyperinflation.
Getting This Right Means Achieving the Right Balance
It is a delicate balance when you seek to keep the economy humming along but at a very modest pace, and the Fed combats both too much growth and not enough of it. Both are dangerous, but if anything, too much growth is the more dangerous of the two, because it can cause hyperinflation, and we’ve seen this destroy the economies of countries before.
We need only look to Venezuela to see what sort of damage that can occur when inflation is not managed properly. In 2018, the inflation rate in Venezuela was about 1.7 million percent. If we had a million dollars to start the year, by the time it was over this would have shrunk in value to about $6. A lifetime of savings gets reduced to pocket change in just a single year, and this is not a problem that just occurred in 2018, it’s been going on for 35 years, getting worse and worse each year.
These things start out small, and then just keep deteriorating without sound management, much like a single match can start a wildfire. Once enough of the forest is burning, it just gets out of control and you reach a point where the central bank’s tools are much like pouring buckets of water on it, there’s too much fire to be able to put it out with the amount of water they have.
This is why the Fed is more eager to act to put out fires than to fan the flames, and why we saw rate hikes last year for example, but no rate cuts this year yet. The other thing that we need to realize is that it is OK that things slow down a bit like they have been doing, and the Fed not only is concerned, it is quite happy with the way things are now, and will only act if there is a good enough reason to.
On Wednesday, they showed us their hand again, and the current plan is not to have any rate cuts this year, although that is subject to revision if needed. This is not unexpected though for those who know enough about what it takes for them to do such a thing, and growth of 2.1% and inflation above 1.5% isn’t just bad, it’s actually quite good and even desirable.
We also learned that there are plans to cut rates in 2020, and to raise them back up again in 2021. They look at all the data out there and they just aren’t seeing a reason to act now, even though one committee member did vote for a rate cut this time. The rest are happy to stand pat right now.
We need to realize that the potential threat here is a recession, an actual one, not our sliding down the table a little bit and people becoming afraid that the momentum of this will carry us too close to the edge. Inflation has dropped a bit but that’s seen as fine, and there is nothing out there right now that would suggest it’s headed toward the negative, deflation.
The reason this would be bad is that it contracts our economy too much, and the Fed is indeed committed to growth, which is a big part of their mandate. This growth needs to be not too little, not too much, but instead what we could call within an acceptable and healthy range, just right in other words.
Growth is Nice, But Inflation Matters A Lot as Well
Higher growth levels look nice from a nominal perspective, for instance seeing our stock portfolio rise by another 5%, but if you get that much inflation to go with it, it becomes a wash, meaning you not only have not made more, you have made nothing. If inflation is even higher, our real growth becomes negative.
Investors don’t pay enough attention to this generally, or perhaps not even any, but someone has to do it, which is our parents essentially, the Federal Reserve. The adults have to see the big picture here, because if the kids are left to decide this, they will just want to keep partying and regret it later.
It is therefore quite refreshing that we heard the Fed tell us that things are still looking good but they still have a close eye on our well-being, and not see the market take this as a disappointment and sell off on account of it. The market rose quite significantly in the buildup to this latest meeting, and when the word was no, they accepted it quite nicely.
The media is still bent on portraying this as a message that the Fed is eager to cut rates soon, even though that was not the message that was delivered. If needed, they will act, but only if needed, and only if they decide it is needed, not investors or Donald Trump, who would love to see some partying going on leading up to the next election.
This is why it is so important that the kids don’t run the house and this is left up to the adults, adults who wisely ignore any of the whining or begging that kids often engage in when they don’t get their way. It doesn’t really matter much whether they fully understand that this is all for their own good, so long as the adults continue to exercise their wisdom.
You can count on that with this version of the Open Market Committee, and while mistakes are certainly made at times, this committee is distinguishing themselves quite well in their role as sound guardians of our economy.
If Trump really wants to up the stakes, he will work hard on getting the China deal done, and it actually looks like he is right now. That’s one thing that will help both the U.S. economy and the stock market as well, should this be the primary focus, and if other goals such as how tough we may look or how good we may look in the media get rightfully cast aside or at least put into perspective.
If Donald Trump really wants a legacy, he has an opportunity to do it with trade, not by pretending he has power over the Federal Reserve and not just asks for more but demands it.
Meanwhile, it appears to be business as usual at the stock markets, and while there is usually plenty of things that emerge, worrying about the economy too much should not be one of them right now, and it seems that we are understanding this a little better now at least.