Does Jerome Powell really believe what he's saying about rate cuts?
Posted August 1, 2019 1:18 p.m. EDT
CNN — Federal Reserve chairman Jerome Powell had the chance Wednesday to show the financial markets (and President Donald Trump) that he has heard their message loud and clear, by promising the Fed would lower rates numerous times for the foreseeable future.
Instead, he created more uncertainty about what the Fed plans to do next. You've heard it before: The market hates uncertainty.
Investors were spooked after Powell said Wednesday's cut may be merely "a mid-cycle adjustment to policy," and not "the beginning of a lengthy cutting cycle."
Stocks plunged. Powell later clarified that the Fed wasn't necessarily going to stop with one rate cut after a reporter pointed out the market's steep drop.
Still, Powell almost seemed as if he were unconvinced that the Fed really needed to be cutting rates just yet, and he was doing so only because the market demanded it.
"Ultimately, the Fed needs to look longer-term," said Jason Brady, president and CEO of Thornburg Investment Management. "It strikes me as a little ridiculous to take one data point and extrapolate it. What's silly is thinking that the Fed should change its policy on a day-to-day basis."
If the Fed is truly basing policy on data — as Powell and other Fed members like to say — then why lower rates when the job market remains healthy, American consumers are still spending and the stock market is near record highs?
"The Fed's credibility is at risk. The Fed made a move that wasn't data driven and the market may expect the Fed to do it again," Nela Richardson, investment strategist at Edward Jones, said in an interview with CNN Business.
Potential credibility problem for the Fed
Richardson worries that the rate cut could set a dangerous precedent, especially with a key jobs report due Friday.
What will the Fed do at its next meeting if the unemployment rate continues to hold steady (or even fall further) and wage growth starts to pick up?
"Data dependency used to be the Fed's shield," Richardson said. "But the Fed is moving from being data driven to looking around the corner. Is Powell still looking at the data or ambiguous threats?"
One of those ambiguous threats is the possibility that the US-China trade tension, if unresolved, could eventually cool off the economy in a significant way. But that hasn't happened yet.
"The important question is what's the rationale for a cut now? Is it an insurance cut or are there things on the horizon that have you worried about a recession?" said Tim Urbanowicz, senior fixed income ETF strategist at Invesco.
There are few recession alarm bells in the United States right now, even though the economic malaise in the UK and Europe and a slowdown in China are obvious causes for concern.
But a cynic might argue that the Fed's job is to keep the US economy afloat and not micromanage the global economy. The Fed, by cutting rates now, might be limiting its options down the road in the event of an actual slowdown. Rates are now at 2%, an already very low level by historical standards.
US economy still looks solid
"One of the things the market needs to do is recalibrate its expectations. The fear is Powell has limited bullets — much less than what Fed chairs had in the past when they started to cut rates," Urbanowicz told CNN Business.
Sure, there are some pockets of weakness in the US economy that bear watching, particularly the housing market and manufacturing sector. The ISM Manufacturing Index for July came in a bit lower than expected Thursday morning, for example.
The stock market rallied after that report because investors felt that more data like this could prompt the Fed to cut rates further after all. The Dow rose 300 points.
"It's a 'bad news is good news' situation for the market," Thornburg's Brady said.
Look closer though and you'll find that even that manufacturing number wasn't truly awful. A key component of the index that looks at new order activity actually ticked higher.
"Given the importance of new orders for the future outlook, the fact that order volume appears to be stabilizing rather than continuing to deteriorate is a positive sign," said Jim Baird, partner and chief investment officer for Plante Moran Financial Advisors, in a report.
In other words, the Fed still doesn't have enough evidence yet to start a prolonged series of rate cuts, which is precisely what Powell was trying to tell the market Wednesday.
One investment strategist said that's as it should be — and that Powell was smart to reassert the Fed's dependence on the data and independence from both the federal government and Wall Street.
"I thought Powell actually did a pretty good job," said Dec Mullarkey, managing director of investment strategy with SLC Management. "The markets have been leading the Fed and pricing in all these rate cuts. The Fed conceded. But to Powell's credit, he took back the reins."