By Michael O’Neill
“Let the easy money party continue.” That’s the message Fed Chair Jerome Powell, and his colleagues at the Federal Open Market Committee (FOMC) appear to have given to financial markets. They didn’t lower rates on June 19, but dovish tweaks to the policy statement have the CME Fedwatch tool showing a 100% probability for cuts at the July 31 and December 11 meetings. The decision to leave rates unchanged was not unanimous. St Louis Fed President James Butler wanted lower rates immediately.
Mr Powell opened his press conference by admitting the FOMC made “significant changes to our statement.” Most notably, the Fed gave up being “patient” and now will be “closely monitoring implications of incoming information for the economic outlook.” They also downgraded economic activity to rising at a “moderate pace in June, from May when economic activity was “solid.” Market-based measures of inflation are no longer “remaining low” but have declined.”
The Fed chair blamed the shift in view from the re-emergence of crosscurrents, which included trade developments and global growth which were moderating at the time of the May 1 meeting. He said “apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture report heightened concerns over trade developments. These concerns may have contributed to the drop in business confidence in some recent surveys and may be starting to show through to incoming data. Risk sentiment in financial markets has deteriorated as well. Against this backdrop, inflation remains muted.”
There is no doubt that the Fed turned dovish. Mr Powell admitted it when he said: “many FOMC participants now see that the case for somewhat more accommodative policy has strengthened.”
However, maybe Mr Powell was dovish like a hawk. He said the baseline outlook remains favourable. He pointed out that the economy has performed reasonably well with “solid fundamentals” supporting continued growth and strong employment, which should lead to a pick-up in inflation. Rate cuts may be on the table but according to the dot-plot forecasts, not until 2020. That puts him at odds with President Trump. He wants rate cuts now, and if Powell doesn’t deliver, Trump thinks he can demote him. Powell didn’t agree and said in his press conference “I think the law is clear that I have a four-year term, and I fully intend to serve it.”
President Trump’s opinion is that lower US interest rates will stimulate the economy and create new jobs while “making America great again.” The central bankers of the world disagree. The governors of the Reserve Banks of Australia and New Zealand were forced to cut rates recently mostly because of rising US/China trade tensions. They aren’t alone. European Central Bank and Bank of Canada officials blame the slow pace of policy normalization on “uncertainty related to trade conflicts.” Trump and his trigger-happy tariff finger are the common denominator in all the trade tensions. Perhaps a trade deal will make all global slowdown concerns go away. A cynic might suggest that Mr Trump is encouraging a prolonged US/China trade dispute to force the Fed’s hand into lowering rates.
The major central banks have a dilemma. Many are chopping interest rates to stimulate economic growth and get inflation to target levels, and they may be creating asset bubbles in the process. Low rates have boosted global stock indices into “nosebleed” territory with investors pouring money into IPO’s like it is 1999.
Many will remember the “sure-thing” tech stocks of the 1998-200 era. E-Toys raised $166.0 million in it’s IPO at $20.00/share. Prices soared to $76.00 by the end of the day and then dropped to $0.09 two years later. Drkoop.com turned an IPO of $88.5 million in June 1999 to $0 in 2001. Pets.com was a real dog. It’s IPO raised $82.0 million in February 2000, and it went bankrupt nine months later. Fast forward to May 2019. Ride-hailing service Uber Technologies went public on May 10 at $45.00/share, giving it a market cap of $75.46 billion. The company has never made a profit and its SEC filing warned it might never make a profit. No worries, this time it’s different. Except its always different, and still bad things happen.
How will the central banks respond to a repeat of the tech bubble crash? The Bank of Canada overnight rate is 1.75%, the RBNZ OCR rate is 1.5% and if Fed is at 2.25%. Chopping rates to stimulate growth and inflation hasn’t worked out all that well for the ECB whose benchmark deposit rate is a negative 0.40%. High housing prices in Toronto and Vancouver have made it extremely difficult for first -time buyers to get a foot in the door. Lower interest rates won’t do anything to make housing more affordable.
BoC Governor Poloz pointed out in the Monetary Policy Review, January 9, “trade risks were two-sided—while this dispute could escalate it could also be resolved.” What happens if the trade dispute disappears?
The US and China were close to a trade deal last month just before the American’s accused China of reneging on promises. Talks are restarting at the end of the month. On June 18, Trump tweeted “Had a very good telephone conversation with President Xi of China. We will be having an extended meeting next week at the G-20 in Japan. Our respective teams will begin talks prior to our meeting.”
A trade deal or even a draft of an agreement is a real possibility. It would vindicate Chair Powell, bring the Feds baseline case into focus, and question the need for lower interest rates.
For now, the Fed has spiked the punch, but Trump and his trade agenda have the keys to the liquor cabinet.