Stocks had another nice day Wednesday, with the S&P 500 gaining 0.8% in price terms on the heels of Tuesday’s 2.1% rise.[i] Headlines near universally credited the Fed, citing Chair Jerome Powell’s jawboning about rate cuts and pledging not to sit idle if tariffs start taking a toll. On the whole, this strikes us as an overreaction and another example of investors having far too much faith in the Fed's ability to manipulate US growth rates. If policymakers could control the economy by pushing this button or pulling that lever, the Fed probably wouldn’t be struggling to hit its self-imposed inflation target amid the slowest economic expansion in history. Moreover, as we wrote last week, there is scant (if any) evidence the economy needs Fed intervention. Yet it could be a salve for sentiment, perhaps helping investors move on from 2019’s false fears.
A Wall Street Journal op-ed by economic researcher Donald Luskin highlights why:
Last July, in his first semiannual testimony before Congress, Mr. Powell was asked by Sen. Patrick Toomey (R., Pa.) what he thought of the narrowing yield curve. Mr. Powell answered: “If you raise short-term rates higher than long-term rates, then maybe your policy’s tighter than you think, or it’s tight anyway.”
Then, an inverted yield curve was an if. Today, it is a thing. Thus, one would think a Fed head seeking to preserve his institution’s credibility would be mulling a cut. Not because it is necessary, and not because tariffs are about to bite, but because intellectual consistency is currency. How much ridicule did Bank of England chief Mark Carney take for frequently shifting his criteria for hiking (or not hiking, as things turned out) interest rates in 2014? Former Fed head Ben Bernanke got more than a bit of guff for implying 6.5% unemployment was his trigger point for raising rates above zero—and then passing when 6.5% came and went. So did his successor, Janet Yellen, for saying she would raise rates about six months or so after quantitative easing ended—and then waiting 14 months instead.
At the margin, Fed actions don’t matter as much as whether investors have confidence the Fed will act in a timely and appropriate manner when push comes to shove. A haphazard central bank that says one thing and does another gives an impression of chaos, which can weigh on sentiment and risk taking. But a central bank that just does its thing in the background, acting logically without fuss or fanfare, can give investors one less thing to stew over.
Which brings us back to Powell. The principal benefit of a rate cut or two wouldn’t be the surface change of a non-inverted yield curve. That may help some. But as we have written in recent weeks, the global yield curve swamps any nation’s, and that has been positively sloped this whole time. Even domestically, banks’ funding costs and loan rates are much farther apart than the yield curve would suggest. So returning the US government yield spread to positive territory probably wouldn’t be the huge factor for banks many presume.
But a cut could assuage widespread inversion fears some in the here and now, as well as give folks a little more confidence that a Fed head is watching the market with a consistent viewpoint. It would also give Powell a chance to say, “so we were trying to get inflation in check, and as you see, we got it in check, so go us, and now we can step off the brakes and let everyone get on with life.” We suspect investors would find that much more logical than the alternative of keeping the yield curve inverted while inflation lingers below the Fed’s target.
Now, far be it from us to suggest that Fed consistency is a reason to be bullish. It isn’t, because it a) isn’t assured; b) it likely won’t last, if history is any guide; and c) the Fed isn’t nearly as powerful as many presume. But logical consistency—in at least this one case—in addressing a widely held fear should calm investors’ nerves a bit, which is about all this bull market needs right now to keep climbing, in our view.
[i] Source: FactSet, as of 6/5/2019. S&P 500 Index price return on 6/4/2019 and 6/5/2019.
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