The week started on a tense note and ended somewhere between relaxation and relief. It’s all about the message the Federal Reserve issued, except what it said about interest rates.
Don’t get me wrong, I’m happy to see interest rates go down in the absence of real inflation. After all, there’s no reason for the Fed to prescribe tough medicine if the economy isn’t actually running a fever.
But the rate cut was largely factored into Wall Street’s projections. Most of us already expected the Fed to roll back the yield curve 0.25 percent, taking us all back to the rate environment that prevailed in mid-2018.
The real relief for weary investors emerged in the press conference that followed. While a rate cut is nice, clarity is the best gift of all.
No More Policy Whiplash
Clarity has been in short supply on Wall Street since the Fed abruptly flipped from a hawkish one rate hike per quarter to its current dovish posture.
The reversal wasn’t explained well. So, for a generation of investors who only associate rate cuts with 2008-style economic collapse, anxiety followed.
According to the only narrative they remember, rates go down around a recession and every recession leads to a once-a-century crash. Between the Fed and inverting Treasury yields, it felt like central bankers were bracing for a similar apocalyptic scenario.
But whether you love or hate Fed Chairman Jerome Powell, he laid reality on the line. He doesn’t have any secret data feed that tells him anything that we can’t see in the day-to-day news flow.
They get the same numbers we do. And there’s no esoteric magic guiding their policy decisions, either.
Powell was as clear as it gets. When inflation rises above 2 percent, it’s time for rates to rise. When unemployment edges up instead, rates are clearly too high.
We’re in the middle now. In the absence of appreciable inflation, there’s no reason for rate policy to remain so tight, so the Fed has been scaling back recent hikes until prices start climbing.
October’s meeting will follow the same logic. If inflation picks up, Powell will tighten. Otherwise, there’s room for another cut.
There’s no inherent bias here either way. The Fed now effectively pursues maximum employment and the lowest possible interest rates to sustain roughly 2 percent inflation.
Keep that math in mind and you should know what Powell is thinking at any given moment. You can even check his work. If he strays from that policy path, you can bet against him.
But for now, the logic is incompatible with a domestic recession. Powell has always insisted that the U.S. economy remains strong. The expansion is still alive.
The risk factors he sees are overseas. China is slowing. Europe is stagnant. And questions about trade keep a lot of corporate executives on the sidelines until they get clarity too.
If there’s currently any threat to what’s now the longest expansion cycle in history, it’s going to come from outside our borders. That’s a very different scenario from either the dot-com crash or the credit crash.
The World Goes Its Own Way
As we learned this week, it would take a huge oil shock to push what’s currently a robust U.S. economy into a recession. Knocking half of all Saudi Arabian petroleum offline wasn’t enough.
We’ll gauge the impact of $60 oil per barrel on other countries that aren’t lucky enough to have at least 80 billion barrels of petroleum left to discover and extract. It clearly hasn’t ended the world yet.
I’ll talk more in the near future about this as the opposite of a crisis. This is a chance for Exxon Mobil Corp. (NYSE:XOM) and other U.S. energy exporters to share fuel with the world and buffer any shocks along the way.
For now, however, the central point is that the Fed is making sure it does what it can to soothe tensions overseas as well as here at home. In other words, this feels more like a 1998 rate-cut cycle than anything leading up to a recession.
Back then, it looked like a wave of currency devaluations would spread around the world until Alan Greenspan relaxed U.S. rates to defuse the global situation. It worked. The boom continued for years.
For Powell, the message is slightly different. While the Fed is one of the most influential central banks, our bankers can’t control how other countries regulate their fiscal policy.
With so many countries embracing negative interest rates, the Fed’s tightening bias was starting to look extremely out of place. There was no reason for it and, as far as anyone could tell, the only impact it could have had was ultimately negative.
Jay Powell is a seasoned investor. He knows he should control what he can and avoid worrying about anything else.
He can’t control other countries’ fiscal policy. And he definitely has no power over trade or exchange rates. Ultimately, free markets decide all that.
We’re in a similar position. When the world moves around us, we either maintain course or pivot to get out of the way. The Fed does it on a grand scale. We do it with our own portfolios.
As more people on Wall Street figure that out, the wall of worry will recede again and we can all get back to work picking strong stocks and ignoring weak ones.
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