Jay Powell is a privileged, powerful, wealthy banker, and as such is not somebody that would usually elicit sympathy. Still, watching him attempting to justify an interest rate cut yesterday, it was hard not to feel a little bit sorry for the man. Let’s face it, cutting rates at a time of record lows in unemployment and record highs in the stock market is hard to justify at any time, but coming, as this cut does, after a campaign of vilification from the President, it is even harder.
The fundamental problem Powell faced was that no matter what he did, it could be seen as a political or self-serving move, rather than a logical response to economic conditions. If he cut rates by a significant amount and indicated an intention of more cuts to come, some would see that as a craven submission to political, and to some extent market, pressure. If he refused to do either, it would be seen by others as a petulant attempt to assert independence, even if it meant potentially harming growth.
Given the tendency toward caution that is usually evident in central bankers, it should, therefore, come as no surprise that he and his colleagues on the FOMC chose to look for a middle path. By cutting the Fed Funds rate by the minimum twenty-five basis points, or one-quarter of one percent, then being unclear as to any future intentions, all they managed to do, however, was enrage everyone.
It prompted another Twitter attack from Trump and a market selloff, while also being viewed as a capitulation by the President’s political opponents. Traders, who had somehow convinced themselves that a half-percent cut and a full policy reversal were coming, immediately sold stocks to such an extent that the Dow dropped well over four hundred points before recovering slightly to close down 333 points. The President, somewhat predictably, tweeted that Powell had “let us down” by not going further and/or indicating more cuts to come.
The politics of all this is interesting, but investors should be more concerned with the substance, and what it all means for stocks over the next few months.
I would argue that a small rate cut right now will do little harm, at least in that timeframe, and could even potentially do some good. That doesn’t mean, however, that the market will respond positively.
There are two potential issues in cutting rates.
The first, and most significant, is that it is traditionally seen as an inflationary move. The numbers indicate that that is not a problem. We have had a decade of ultra-low rates and other very accommodative monetary policy, yet during that time, inflation has stayed stubbornly below the Fed’s two percent target rate, with steady, but unspectacular growth.
The second is that any rate cut hurts savers and potentially distorts the bond market. Again though, that has been the case for ten years now. Savers who have not yet been driven out of fixed income by now probably never will be, and the bond market has become accustomed to pricing based on central bank policy rather than market forces.
Neither of those situations is ideal in the long term, but a quarter-point cut changes nothing over the next few months and won’t, in itself, affect economic conditions or stock prices all that much. What will change is the perception of what the Fed will do from here. Based on markets this morning, after traders have had a chance to fully digest Powell’s comments at the press conference, the word that best describes traders right now is confused.
Powell called the move a “mid-cycle adjustment,” which implies that it will be a one-off, but also pointed to several risks to growth that might prompt another cut. In other words, after he had first attempted to follow his two most recent predecessors at the Fed by clearly indicating the FOMC’s intentions, he returned to the tradition of obfuscation by the Federal Reserve.
Traders have no idea where we go from here, and that leads to one obvious conclusion. Every word uttered in public by an FOMC member for weeks to come will be analyzed in detail, and every utterance will prompt an outsized market reaction. That means that, while a sizeable correction or a surge to even higher levels are both possible, the only sure thing is that we are looking at significant volatility, at least until next month’s Fed meeting.
That is good news for traders, but it could be an unsettling time for long-term investors. You should keep in mind though that we are in a long, drawn-out recovery from the Great Recession, and are still looking at sustainable, growth and low inflation. That suggests that riding out the bumpiness, and even buying on drops for the more adventurous, is the preferred strategy.