The annual global central bank conference is scheduled for next week, and on Friday, Federal Reserve chairman Jerome Powell will provide an update on where the Fed is leaning.
With the next Federal Reserve Open Market Committee meeting a month away, with the next announcement not scheduled until September 18, there will be plenty of time for markets to continue to speculate on what will happen at that meeting and what the central bank’s plan will be for the near term.
These things are generally decided on a meeting to meeting basis, during the 8 meetings a year that the FOMC holds. This next one has a 2-month gap, but along the way we get to see a glimpse of how things might have changed since the last meeting when Chairman Jerome Powell speaks during the annual banking retreat next week.
Powell is expected to share his thoughts with us next Friday, at a time where Wall Street is in the grips of concerns over falling treasury yields, which certainly have taken a tumble lately.
There was even a point last Wednesday where the 10-year yield fell below the 2 year, invoking the dreaded yield inversion for a brief time, although by the end of the day the world was put back on its axis. We actually didn’t experience a real inversion this time, and while we did earlier in the year, it was a brief one, but the stock market is so sensitive to this issue that even a brief dip in this pool has them scattering like a scared flock of birds.
Former Fed Chairman Allan Greenspan has even remarked that he envisions the U.S. treasury market going under water with negative yields at some point, even though we’re a long way from that. What we need to realize though is just how big this market is and the massive additional demand that it would take to drive these yields below zero, and it takes a lot more to drive treasury yields that far down than it takes in other countries with considerably smaller national bond markets.
There is only so much demand for treasuries out there, and this is not a matter of bond traders predicting very low inflation or a recession as much as it is sheer demand for the treasuries. It is demand that drives the price up and yields down in turn and while this has increased, there are limitations on the amount of new money that these securities can attract.
Treasury Yields Have Fallen a Lot Since the Last Meeting, But This Was Expected
The demand for treasuries has certainly heated up lately though. The 10-year started the month with a yield of 1.9%, and on Thursday, this had dipped to 1.52%. That’s a very low yield historically, but it still is a fair bit away from the record low of 1.37% we saw three years ago, and the sky did not fall back then.
In spite of these record low yields, and GDP growth dipping to 1.6% in 2016, not only did the Fed not lower rates that year, they actually increased them by a quarter of a point in December of that year. Low treasury yields might scare the stock market, but they don’t scare the Fed, and they are not afraid of these latest ones either.
There isn’t really a good reason why the stock market should be alarmed by this or anything else that’s going on out there right now, but stock markets are far fickler than the Fed is and it doesn’t take all that much wind to blow them off of their feet, for a time anyway.
Markets did recover somewhat on Friday, as we saw the 10-year yield move up from 1.52% to 1.55%, and the spread with the 2-year climb from a single basis point on Wednesday to 13 basis points on Friday, getting back to a level more typical lately, which should provide comfort for those who fear an inversion of these yields.
Consumer spending is now looking up again, and the most recent data has us moving in the right direction again after a lull. With everything else well in the green, this will serve to take us away from the need for further rate cuts in the near term, even though the market seems to somehow think that we’ll see one or more rate cuts by the end of the year.
If low yields were actually seen to be a problem, a rate cut would put them down even further, and we would actually need a rate hike to set them in the other direction. We did get a rate cut recently, and it’s normal for yields to go down after these things, and the yields are the tail of this dog, and tails do not wag dogs.
Another myth out there is that the Fed pays attention to how much markets have priced in rate cuts and account for such things in their decisions. The point of an independent Fed is to allow them to make decisions about the economy according to the actual merits involved and not be subject to outside influence, to not enact policy to appease anyone, and financial markets are certainly included in who they are not out to skew policy to try to appease.
Another fairly popular view is that keeping stock markets moving up is part of what the Fed does. This view comes from the idea that financial markets somehow play a central role in the economy, and therefore part of the goal of economic stability is to keep stock markets stable and even cater to them if needed. The economy itself is the dog here, with financial markets being the tail, and once again, the tail does not wag the dog.
We are privy to a lot of the information out there that the Fed does actually pay attention to, and we haven’t seen much at all to think that their position has changed all that much since the next meeting, where we were told that things look good but a little mid-cycle help wouldn’t hurt. Inflation has ticked down a bit and that quarter point won’t do too much but according to the Fed as well as the economic numbers, not much help is needed here.
Optimism for More Rate Cuts Abound, Reality Be Damned
The very moment this was all announced, markets started pricing in another rate cut, or two, as if the Fed were lying to us and we all know that we need a lot more than this. The market does not get to decide such things though and if they predict wrongly, they will simply have to re-adjust their views once the truth comes out.
The lower yields on treasuries will help things though by expanding the credit market in the same fashion and by way of similar mechanisms to a rate cut, and this is actually one of the targets of these cuts. While the stock market has a voracious appetite for Fed cuts and even fantasizes about them, it doesn’t get too excited about economic stimulus coming from lower treasury yields, but once again, stock markets are fickler than economists are.
We need not worry about yields dropping further, if they do, although people will still worry and especially if the 2 year doesn’t move in lock step with the 10. We especially do not want to be thinking that this will influence the Fed because they do try to limit themselves to matters of genuine concern, which this is not.
One of the remarks on the internet describing this latest rate cut, the first one in 11 years, described the move as the “Fed lowered rate despite steady growth.” We could have added that they lowered the rate despite much of an indication that it was needed, and actually acted pretty proactively to stem concerns that projections might deteriorate due to the escalation of tariffs.
This level of deterioration is fairly minor though, but so has been the response, but it has already been measured out and it would take a real deviation from their current path for them to double down in September’s meeting.
This was the case going into last meeting as well though, where they told us that there wasn’t any good reason not to just stay the course but ended up altering it a bit anyway. We can’t really predict what the Fed will do with any certainty but we still need to base our predictions upon the facts and not just hope or a misunderstanding of what the objectives are with this policy.
We still have another month to go to get there, but we will at least have more guidance next Friday, even though we may be prone to listen with a biased ear and allow our own perceptions to be mixed in with the message to prop up our hope for more.
We should not be holding our breath for another rate cut right now though, as the data really does not support one, and the data will have to change before that gets put on the table. It might, but this just isn’t happening right now.
Things continue to hum along quite nicely as far as the economy is concerned, and the resumption of the consumer spending curve that has moved virtually straight up for the last 10 years is back, having overcome this little lull that we’ve had and getting things back in the right direction. This is one of the things that the Fed looks at and they will be smiling along with the rest of us about this, and we expect some smiles next Friday as well, even though the market may be hoping for the opposite.