Fed Faces a Key Decision on Rates

The Fed faces a key decision on rates that undoubtedly will move the markets once its next move is known.

Following a three-day market rally off key technical support as I wrote this e-letter on Thursday, Aug. 21, the stock market seemed uncertain about its direction. By the time you read this update from me, the Fed summit in Jackson Hole, Wyoming, will have wrapped up on Saturday, Aug. 24, and investors will be anxiously awaiting word about what will happen with the next round of tariffs that is set to take effect on Saturday, Sept. 1.

I have insights I want to share with you about what to expect in the weeks and months ahead, while I try to avoid raising needless alarms the way some market commentators and broadcasters on television do. Speculation early Thursday morning surfaced in news reports about better-than-expected leading indicators for July (+0.05) that stemmed the flurry buying in bonds and gold.

Fed Faces a Key Decision with No Consensus on Interest Rates

What I noticed in watching CNBC on Aug. 21 is that Fed officials who spoke on camera as the summit began expressed very different opinions on fiscal policy. Kansas City Fed President George reiterated her view against the need for a rate cut last month, while Philadelphia Fed President Harker said he doesn’t support further economic stimulus right now.

Despite the “wait-and-see” position echoed by the two Fed governors, the market endured another brief spread inversion of the 2- and 10-year Treasuries last week following a discouraging U.S. Markit flash manufacturing Purchasing Managers’ Index (PMI) reading for August that came in at 49.9 and down from July’s reading of 50.4. At the same time, the U.S. Markit’s service sector PMI reading fell to 50.9, down from July’s reading of 53.0.

Economists were forecasting the index to come in at 52.9. Sentiment in the service sector is at its lowest point in three months, the report said. Any reading below 50.0 shows contraction in activity. According to some economists the drop in the flash U.S. PMI data is raising the threat of a recession.

“August’s survey data provides a clear signal that economic growth has continued to soften in the third quarter,” said Tim Moore, economics associate director at IHS Markit. “The PMIs for manufacturing and services remain much weaker than at the beginning of 2019 and collectively point to annualized GDP growth of around 1.5%. The most concerning aspect of the latest data is a slowdown in new business growth to its weakest in a decade, driven by a sharp loss of momentum across the service sector.”

Fed Faces a Key Decision on Rates that Could Feature a New Cut

From my perspective, the Fed can be proactive and cut rates by 50 basis points and get way out in front of what is shaping up to be reduced gross domestic product (GDP) growth as the year progresses to get the yield curve to steepen and correct the threat of prolonged inversion. Or, the Fed can do what it has been doing and remain in a reactionary posture that is backward looking.

There is a lot of chatter about strong consumer spending but look where the strength of spending is — Walmart (NYSE:WMT), Costco (NASDAQ:COST), Home Depot (NYSE:HD), Lowe’s (NYSE:LOW), Target (NYSE:TGT) and other retailers of necessity. The charts of stocks like Macy’s (NYSE:M), Nordstrom’s (NYSE:JWN), Dillard’s (NYSE:DDS), Foot Locker (NYSE:FL), Tiffany’s (NYSE:TIF), L Brands (NYSE:LB), Gap (NYSE:GPS), Bed Bath & Beyond (NASDAQ:BBBY), among other more discretionary specialty retailers, are flat out ugly, sporting huge year-over-year losses. Before getting too worked up over the retail rally, it is not broad based. Even Amazon (NASDAQ:AMZN) shares are barely holding their 200-day moving average.

On the surface, the recent blip in spending sounds good and has been prompted by lower interest rates with which to finance purchases. However, overall consumer debt skyrocketed to a record $13.7 trillion in the first quarter, according to the New York Federal Reserve. That total is led by big-ticket mortgage debt, tipping near $10 trillion, binging credit card spending and escalating student loans of around $1.5 trillion. Perhaps not surprisingly, more than half of Americans have either no emergency savings, or less than enough to cover three months of expenses. That’s the highest percentage since Bankrate.com started tracking the data nine years ago.

Fed Faces a Key Decision on Rates, While Investors Need a Strategy

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