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Fed Buys Economic "Insurance" With Rate Cut - Wealth Managers React
Tom Burroughes
1 August 2019
The has cut interest rates by 0.25 per cent, or 25 basis points, to a target range of 2 per cent from 2.25 per cent. This is in spite of what is, as far as data seems to suggest, a strong economy without much slack in the system. Economists argue, however, that fears about an escalating trade war may require an “insurance”-style cut now and the markets appear to be pricing in further reductions. The decision was not unanimous: Kansas City Fed chief Esther George and Boston Fed president Eric Rosengren dissented on the decision to cut rates, instead preferring an unchanged stance on interest rates. Older investors may scratch their heads about how the world’s most powerful central bank thinks it is necessary to loosen monetary policy when – according to the Trump administration and official figures – the US economy is in such good shape. It is important to remember that when inflation (which is low) is factored in, real interest rates are barely positive. Over time, lousy returns on cash and cash-like investments hold down savings, and that’s bad for the kind of long-term investment that drives productivity growth and real wages. It has been argued that one of the reasons why wage growth has been sluggish in recent years is precisely because of low real savings rates in the US (and to some degree, other parts of the West). There is also the argument that the Fed has so massively expanded its balance sheet post-2008 that it has limited room to keep rates higher even if the economics warranted it. Low interest rates also mean, as wealth managers know, that investors must go higher up the risk spectrum than they might otherwise like to get returns. It also explains some of the hunger for alternative investments, such as private capital, equity, forms of real estate, infrastructure, commodities, and precious metals. The environment has prompted investors to be willing to take the pain of less liquidity because they need the returns. Sooner or later, this equation is not going to add up any more. With these thoughts out of the way, here are some reactions from wealth managers in Europe from yesterday’s cut by the Federal Reserve. We may update with reactions from US managers as they come in. To add your voice to the debate, email tom.burroughes@wealthbriefing.com chair Jerome J Powell didn’t deliver any firm commitments on interest rate cuts, he will get another opportunity at the Kansas City Fed Economic Symposium, better known as Jackson Hole, on August 22-24, where he could provide updated guidance to markets. The Fed’s decision was framed against an assessment of the economic outlook which was pretty much unchanged from the June meeting, in that the labor market was still assessed to be strong and that activity was seen rising at a moderate pace. Meanwhile inflation continued to be assessed as running below the Fed’s 2 per cent target. In light of the solid labor market and seemingly robust economy the rationale for last night’s cut came in the form of concerns around downside risks from the global backdrop (trade frictions) and muted inflation pressures. Indeed we very much view last night’s move as a precautionary cut given that the unemployment rate stands around a 50-year low and given our expectation that the US should see growth of 2.5 per cent this year. Olivier Marciot, investment manager, In the Fed’s Open Market Committee statement the description of the domestic economy remained the same, and forward guidance was slightly watered down as the committee stated its intent to continue monitoring incoming information rather than ‘closely’ monitor. There were two dissents in favor of no change: George and Rosengren. While both are regional Fed presidents, two dissents is unusual and suggests a split on the FOMC. However, nobody dissented in favour of a 50bps cut. The statement outlined that the Fed will conclude the reduction in its balance sheet two months earlier than previously indicated. It did not come as a surprise, as to continue shrinking the balance sheet would work at cross purposes to the rate cut (even though the balance sheet was originally supposed to be separate from active monetary policy decisions). Gregory Perdon, co-CIO at , the UK private bank Whatever happened to the theory that we need fuel in the tank to support us during a real downturn? There is no evidence of a material slow down, so why is the Fed cutting? Let’s face it, the trade wars will end before the next Presidential election regardless of what deal Trump can secure - and when that happens, international trade will come roaring back and confidence will rocket – at that stage, the Fed will be forced to back track and shock the market. Do markets like reverses? Of course not.
The Fed cut rates last night by 25bps, but the lack of forward guidance disappointed an aggressively priced market which has taken out 10bps of future cuts.
If Powell wants a good book deal, he should stand-up to the President and tell him that the last time he (Powell) checked, the Fed was in charge of monetary policy not the White House. The S&P is at an all-time high, unemployment is rock solid, little cracks in the housing façade and credit is largely okay (except some low grade). Why did they do it? It doesn’t seem sensible to me.