Commentaries
PMC Weekly Review – June 17, 2019
The last few weeks have brought a noticeable change in the interest rates narrative. Many commentators and prognosticators are now discussing the possibility of the Federal Reserve (the Fed) cutting interest rates at either next week’s FOMC meeting or the following one in July. What makes this an eyebrow-raising development is that it is a sea change in what was considered common wisdom at the beginning of the year. To some degree, this 180-degree about face is just the way things are in the capital markets. A more cynical and/or jaded observer would probably just add to their ledger another entry on the market’s attention-deficit disorder and overemphasis on the short term. Although we cannot predict what the Fed will do at its next meeting, we offer a summary of recent developments that appear to have caused the change in market consensus.
The ongoing trade impasse with China is the most prominent item as of this writing, raising the possibility that tariffs on both sides will be dramatically increased. However, much of this is more likely to be posturing in advance of the upcoming G20 Summit. The threat of raising tariffs is an arrow the Trump Administration often pulls out of its quiver. However, as is standard in most contentious negotiations, what both sides currently are demanding in their starting position is probably higher than what they ultimately will accept. Note that China, for its part, has walked away from what were considered previously agreed-to items, and appears to be taking a harder line going into the Summit. If no deal is struck and tariffs surge, stalled GDP growth may result, forcing the Fed to adopt looser monetary policy as insurance against recession.
Jobs are another area of concern. The most recent data point on this front, the nonfarm payroll jobs for May, came in much weaker than expected. Only 75,000 jobs were added during the month. Previous months’ readings were revised downwards as well. ADP’s private payroll survey showed similar weakness of 27,000 jobs created in May vs. expectations of 185,000. The question is whether these are blips in what thus far has been a strong job market. Unemployment in absolute terms is at generational lows. It stands to reason that any concrete action should be delayed until additional evidence shows that a negative trend has truly developed. The Fed does need to be anticipatory rather than reactionary though, so it may take action regardless of definitive evidence.
Also, inflation remains under control. Recent year-over-year core CPI numbers came in at 2.00% for May and 2.10% for April. This is encouraging, given the Fed’s dual mandate of encouraging economic growth and controlling inflation. When inflation is low, the Fed is free to act in support of economic growth. These recent CPI data points paint a more benign inflation picture than they did six months ago. It does not appear that the Fed sees inflation being ignited to any great degree.
Last but not least, current opinion is that the Fed itself may be starting to signal a more dovish stance. Federal Reserve Vice Chairman Richard Clarida recently made comments to the effect of “insurance” rate cuts being possible. How much to make of this is hard to decide, as the parsing of Fed commentary is typically as reliable as the portent derived from sacrificing a pig before a Roman legion entered battle. In addition, the comments of individual Fed members do not necessarily extend to the body as a whole. That said, it appears that the consensus view now is that the Fed considers its baseline of actions to be either no change or a decrease in the federal funds rate. Increases seem to be off the table.
Interest rates are, as other, more illustrious commentators have quipped, the gravity of finance. Lower interest rates justify higher valuations for all assets. So this change in the narrative on future Fed policy has, to some degree, nudged markets higher over the last couple of weeks. Long-term investors should keep in mind that in spite of what the Fed does next week, its long-term view is that a normalized rate structure is higher than where we are now.
David Chandler, CFA
VP, Senior Investment Analyst
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