FED STIMULUS WHETHER WE NEED IT OR NOT

The stock market jumped at the open after the Federal Reserve rate cut yesterday. At the moment, the Dow is up 300 pts and the SPX is up 1%. The tech sector (+2.2%) is leading the way, along with communications (+1.3%) and consumer staples (+1.2%). Financials are lagging—up a mere .3%--in the wake of the rate cut. Strangely enough, the dollar strengthened after the Fed cut, probably because other central banks around the world (i.e. Europe, China) are expected to pursue stimulus more aggressively than the US Fed in the near future. So commodities are mostly trading lower today. WTI crude sank 2.7% to trade around $57/barrel after a report confirming a rebound in US production levels (12.2 million barrels per day). Traders are saying the world is well supplied. In addition, US and Chinese trade negotiators parted ways after accomplishing nothing this week and traders are using that as an excuse to sell. Bonds are up in price, down in yield today. From short-term to long-term, from corporates to Treasuries, the bond market is up across the board. The 10-year Treasury Note yield fell back to 1.95%, matching the lowest level going back to November 2016.

The Federal Reserve’s Open Market Committee wrapped up its monthly policy meeting and announced a .25% reduction in the key Fed-funds interest rate. The cut was immediately reflected in all sorts of rates, including mortgages, auto loans and credit card rates. This is the first Fed rate cut since 2008. Fed Chair Jerome Powell said the move was necessary due to “global developments” and “muted inflation.” In other words, the trade war and other factors have reduced economic growth all around the world. In addition, the Fed announced a halt to its balance sheet runoff in August. Recall that the Fed bought billions of dollars in bonds over several years following the Housing Crisis in order to keep interest rates low and stimulate the economy. Over the last couple of years, the Fed has gradually allowed those bonds to mature without reinvesting. But now it judges that the economy can’t handle the unwind. Mr. Powell explained the Fed’s decisions thus: “We’re thinking of [the rate cut] essentially as a [one-off] midcycle adjustment to policy,” rather than the beginning of a string of cuts. In other words, there was “definitely an insurance aspect” to this rate cut, and he believes that periodic surgical adjustments to monetary policy can keep the “economy on track…and the outlook favorable.”

Traders—and automated trading algorithms—were initially confused by the announcement. Immediately afterward, the 10-year Treasury yield rose, stocks fell, and the dollar strengthened. There was definitely a feeling that Mr. Powell didn’t go far enough with his shift to dovish monetary policy. Some investors point out that manufacturing, business investment, and foreign growth has declined; other central banks are easing more aggressively and that’s what is needed here. But today, stocks are up strongly and bond yields are lower. And that seems to reflect a consensus opinion that the Fed will provide stimulus as needed in the future.

Heavy hitters are weighing in on the Fed’s decision today. Famed investor Lee Cooperman said there’s no good reason for the Fed to cut interest rates and move to monetary easing. He noted the economy is growing at trend level, corporate profits are decent, businesses are not pessimistic, and recession is not on the way. “We are rewarding one questionable policy (trade war) with another questionable policy (cutting interest rates).” He says the stock market is “OK here,” meaning he doesn’t believe it is overvalued. By contrast, he sees no value in the bond market because rates are too low. Jim Paulsen of Leuthold Group says “It’s bizarre to be talking about a weak economy” with consumer spending so strong. He points out that the goal of the Fed rate cut wasn’t to stimulate growth, but to take the fear out of the market. But it really didn’t even accomplish that. It didn’t steepen the yield curve, didn’t boost inflation expectations and doesn’t seem to have increased confidence in the economy. But whether we need it or not, stimulus is here. The big question is whether that stimulus boosts corporate earnings and the economy. “The good bet is, it’s gonna work.”


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