Federal Reserve Monetary Policy
The Federal Reserve meets on September 18. The consensus is that the Fed will cut the rate another 25 basis points to 2.0% from its current level of 2.25 percent. U.S. economic data looks good as a whole. The rate cut is expected to be in response to slowing growth outside the U.S., although this is not one of the Fed’s mandates.
The most recent year-over-year inflation rate was 1.8%. The next release is scheduled for September 12. We look for the rate to notch up a bit to 1.9%, while the market expects it to remain at 1.8 percent. The outlook for long-term inflation continues to be muted, in the U.S. and around the globe.
The last ISM manufacturing report dipped below 50 for the first time since mid-2016. A number below 50 suggests manufacturing is slowing. Market participants looking for lower interest rates use this as evidence that the economy is slowing. We see it as just one number; it will take more data to build a thesis. Manufacturing is about 11% of the U.S. economy.
Central banks likely will be accused of not using the powerful tools at their disposal for not stimulating economic growth sooner. Those tools appear to have outlived their effectiveness and power, at least in this cycle – and may be backfiring as consumers curtail purchases while allocating more toward savings, as retirement plans slip further behind targeted goals. Retirees are curtailing purchases, too, because monthly income from their retirement accounts has declined.
If global growth above current levels is the primary economic mission, we feel it is necessary for someone to step forward with a new plan other than leaning on central bank monetary policy.
Just last month, we mentioned that about $14 trillion of debt around the world has a negative yield. Today, that number is about $17 trillion. So far, this new investment phenomenon of negative rates has not caught the interest of U.S. investors.
The closer bond yields get to zero percent, the more volatile bond prices become. Longer bonds are more volatile than shorter bonds. The risk reward profile for bonds is bent out of shape. To help control this distortion, we are looking to keep the maturity of new bond purchases to five years or less.
We feel that the Fed realizes the damage negative interest rates could have and intends to avoid that situation if possible. This does not mean we will never see negative interest rates in the U.S. If we do see them, we believe the interval will be limited.
The prospect for further Fed Fund rate cuts has the stock market all excited again as it marches back toward its recent highs, but with a bit more day-to-day volatility.
The forecast for Fed Funds a year from now is 1.12% – about 100 basis points lower than it is right now. While Federal Reserve monetary policy is having a limited effect on generating economic growth, it is like cocaine for corporate CFOs who have become addicted to issuing debt and using the proceeds to repurchase company stock. If the economy does eventually slow down and top-line corporate profits start to slide, reducing stock outstanding is one way of maintaining attractive earnings per share.
The market still favors growth investing over value investing, large cap stocks over mid and small caps, and domestic investing over foreign investing.
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