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July 5, 2019

A Bassackwards Cut Rate?

The media narrative that the U.S. economy is in trouble – many are saying on the edge of recession – has become so powerful and persuasive that few readers give it a second thought.  A few thoughts to encourage further consideration:

  • The rate cuts that the Fed now seems to be planning are unwarranted. The Fed is not tight.  The Fed still has $1.4 trillion in excess reserves in the system, so it can hardly be called tight by any stretch of the imagination.
  • The federal funds rate is currently 2.375% and no one can keep a straight face and say that this interest rate is keeping anyone, anywhere from making an investment.
  • Rates themselves don’t cause recessions, it’s the reason rates move that really matters.
  • It is when the Fed withdraws too many reserves, pushing the federal funds rate above the pace of nominal GDP growth, that the economic tides turn toward recession. 
  • Over the past two years, nominal GDP is up at a 4.8% annualized rate, twice the current federal funds rate.
  • Some argue a slowdown in foreign growth should have the Fed concerned. But we know of no U.S. recession ever caused by weakness overseas. Japan collapsed in the 1990s, the U.S. boomed. 
  • Some are concerned over the low 75,000 new jobs added in May.  Take a look at May 2012, or December 2013, or May 2016, or September 2017, or February 2019. All months at first came in weaker than the May report and not one signaled recession.
  • What you may want to be focused on is initial unemployment claims as a share of total employment at the lowest reading ever. 
  • Job openings, are 1.6 million greater than the total unemployed.
  • Retail sales are booming, up 10.9% in the past three months at an annual rate. 
  • After revisions, real GDP likely grew 3.3% at an annual rate in Q1 and is likely to rise 2.0% in Q2 (held down by a 1.0 point slowdown in inventories). 
  • The troubling notion of the proposed rate cut is that all those who think they see a recession will become convinced that the Fed avoided it, even though it was never coming.
  • The inverted yield curves, as we now see between the 3-month and 10-year Treasury yields, often proceed recessions. But typically, those inversions have happened when the Fed took out too many reserves from the system, which is not the case today.
  • Today’s inversion is based, completely, on the market pricing in future rate cuts. This is not your classic yield curve inversion. 
  • We think a rate cut is backwards.  However, it makes our case for stock valuations even easier to defend