What Does the Fed Rate Cut Really Mean?
The market will recognize a financial basket case for what it is...
Last week, Jerome Powell and the Federal Reserve cut the benchmark federal funds rate by 0.50%, 50 basis points, from 5.375% to 4.875% (using range midpoints). Hardly a surprise, the move was anticipated by markets for the last several weeks. Related interest rates all declined by at least the same amount leading up to the official rate cut announcement. In the case of US treasuries, rates have declined far more than 50 basis points over the last few months, as the jawboning for further rate cuts this year has been accepted and priced in. Along with the rate cut, the Fed is forecasting a “terminal” fed funds rate of 2.75-3.00% by 2026, implying an additional 2%, 200 basis points, in rate cuts by that time.
Capital markets, including stocks and housing, are at all-time highs. Unemployment, by the government’s measure, is quite low. The government’s measure of consumer price inflation, CPI, is above the 2% target and has been continuously for over three years. All of these factors indicate that attempting to “stimulate the economy” through lower interest rates is uncalled for. In fact, by the Fed’s own historic explanations, a rate increase would seem more appropriate. Given all of that, what was the Fed’s rationale for this move?
Just the Facts
According to Powell himself, the economy is strong, but the rate cut ensures that it stays that way. This is pure nonsense. More likely, the Fed is choosing to focus on one political issue, unemployment, at the expense of another, price inflation.
Rate cuts of 50 basis points often reflect existing or impending trouble in the economy. The last few 50 basis point cuts all occurred during or immediately prior to periods of economic stagnation, what we call “recession” (I will avoid this term as its definition is reductive and, in any case, technical recession can be combatted through increased government spending, which is not a sign of economic health).
To wit, in March 2020, an emergency cut of 1% was made in the midst of the covid panic and related downturn. Multiple rate cuts of at least 50 basis points occurred in 2008, in the wake of the global financial crisis. Immediately following the 9/11 attacks, during the dotcom bust, rates were cut by 50 basis points. During the shallow downturn of 1990, rates were cut multiple times by 25-50 basis points.
Between A Rock and a Hard Place
Based on the facts, it’s likely the Fed concluded that inflation is now a more acceptable political liability than unemployment and general economic slowdown. Note that unemployment and general economic slowdown have been with us for some time, they have simply been hidden behind absurd government-curated metrics.
You wouldn’t know it by reviewing jobs reports (specifically the media-reported establishment survey), but there are fewer employed American workers today than there were a year ago – a condition that generally accompanies or precedes economic slowdown. Full-time workers have also been in decline. Over the last year, full-time jobs have declined by roughly 1 million while part-time jobs have increased by the same amount. The middle-class American economy is increasingly characterized by people working multiple part-time jobs to make ends meet.
The low-rate path the Fed is now on signals continued inflation and a continued inability for the economy to strengthen organically. Instead, low rates will encourage more malinvestment, speculation in capital markets, and a profusion of low-quality jobs in unproductive areas. All of these are negatives for the main street economy.
On the other hand, beneficiaries of this latest loose-money regime include the financial and political classes. Banks in particular will see loan values, booked as assets on their balance sheets, rise as rates decline, taking pressure off of their attempts to hide mark-to-market losses – primarily from commercial real estate exposure – and avoid depositor runs. Wall Streeters and other capital market speculators will see a rise in transaction volume, and therefore higher fee income. The political class will of course harvest the benefits of temporarily lower treasury rates by increasing spending on pet projects, to the detriment of average Americans.
We Plan, the Fed Laughs
A brilliant philosopher once said that we can ignore reality, but we can’t ignore the consequences of ignoring reality.
It is indisputable that the Fed – a political organization at heart – factored one more item into its decision to set off on a rate cutting path – the unsustainable condition of the federal government’s finances, specifically ballooning interest payments that currently stand at over $1 trillion annually.
In trying to evade uncontrollable government interest costs by forcing rates lower, the Fed will only meet its destiny on the path it takes to avoid it. Lower rates grease the skids for more government spending, which will balloon deficits and national debt even more. Interest costs will continue to climb higher and, ultimately, forcing rates lower simply won’t work. The market will recognize a financial basket case for what it is, and charge rates commensurate with risk, regardless of the Fed’s attempts at control.
Unfortunately for all of us, those at the Fed and in government at large continue to heap Band-Aid upon Band-Aid (and not new, clean Band-Aids, either; they are using discarded, infected Band-Aids) without any concern for or perhaps awareness of the real problems of their own making: government spending and intervention in markets. As we have discussed before, savers and those who act prudently with their money will be harmed as their ability to earn a positive and safe real yield is reduced with each rate cut. Oh well, must be time to hop into Nvidia.