Jerome Powell Is Between A Rock And A Hard Place
One of the major drags on the market, besides trade wars, has been uncertainty about whether the Fed will raise rates this month. Despite the verbal bravado of Federal Reserve Chairman, Jerome Powell, over how strong the U.S. economy is, he doesn’t live in a vacuum.
Powell’s borne the brunt of President Trump’s recent accusations that the Fed’s hikes are what’s hurting the stock market and threatening the economy. That lead to a media debate over whether Powell would “cave” to Trump or demonstrate that the Fed is the independent body that it’s legally designed to be, and continue with planned hikes anyway.
Powell’s recently indicated again that he planned to go ahead with another 0.25 rate hike when the Fed meets Dec. 19, which would be the fourth increase this year.
But on Nov. 28, he revealed something in his speech at the Economic Club of New York that I’ve been predicting. He dialed back talk about rate hikes. He said that rates were “just below” neutral. That contrasted sharply with his comments from Oct. 3rd when he said “We are a long way from neutral at this point.”
In other words, he’s turned dovish.
That’s a major shift in less than two months’ time. But why the change? It likely had much less to do with pressure from Trump than deteriorating economic and market conditions. Heavy market volatility was just starting to return when he his Oct. 3 comment. It’s only gotten worse since then. At some point, the wobbling in the financial markets must have gotten to him.
As the Daily Reckoning’s, Brian Maher said, single-day losses of 300, 500, 700 — 800 points — seem almost commonplace now. “The stock market is a wreck of nerves these days,” he said, “like a man walking point in a dark enemy jungle.”
There are just so many points of uncertainty and weakness brewing in the markets, both within the U.S. and the global economy overall.
During 2017, a large part of the global economy was enjoying what appeared to be a sustained period of growth. Large advanced economies like the U.S., the EU and China were bustling and many emerging-market countries were healthy.
This year, that trend has all but reversed. Uncertainty has crept into stock and bond markets, along with economies around the world. China’s economic growth has fallen to its weakest level since 2009. At home, spreads are widening on corporate credit, lots of CEO are warning about slowing growth, and we’ve seen an 8.9% decline in new home sales.
What has emerged is a growing fear that the future could be gloomier than many analysts, governments and central bank leaders anticipated. There are now two major factors that could curtail growth in the U.S.
One is the Federal Reserve itself. If the Fed were to continue raising rates too quickly, it would cause government, corporate and consumer debt payments to increase. Such a move would lead to higher deficits and defaults — and lower economic growth.
Second, while President Trump’s estimated $1.5 trillion in tax cuts have contributed to boosting U.S. GDP this year, the same impact is unlikely to carry on into next year.
Because of the economic boom and tax stimulus, companies have had a lot of cash to buy their own shares. By implementing corporate buyback programs, the private sector has been able to keep share prices high, despite increasing volatility. Unfortunately, stock buybacks alone are not enough to keep GDP rising.
Now there’s a considerable reason to believe that on the back of slower buybacks and the threat of economic bubbles, the Fed will have to reconsider their policy of hiking interest rates. Powell’s latest dovish comments were a reaction to realities like the ongoing trade war, for example, which despite the recent “truce,” is far from over.
In fact, the U.S. may have broken the truce by having Canadian police arrest Meng Wanzhou, the CFO of Huawei, which is China’s largest telecom equipment manufacturer.
Though no charges have actually been specified, U.S. officials suspect Huawei uses its smartphone technology to spy on Americans. They also have raised suspicions that the firm has violated international sanctions against Iran. Meng will likely be extradited to the U.S. to face trial unless some kind of deal can be worked out. But don’t expect China to take it lying down.
U.S. GDP is still growing and probably will into next year. But it could all come unglued after that. A previous article by economists Nouriel Roubini and Brunello Rosa lists ten reasons why 2020 could be the year of the next financial crisis. They range from the economic to the geopolitical triggers. The main four reasons are:
- By 2020, “a modest fiscal drag will pull growth from 3% to slightly below 2%.”
- Trump’s trade wars “will almost certainly escalate, leading to slower growth and higher inflation” around the world.
- Growth outside of the U.S. will likely slow down – especially if more countries retaliate against U.S. protectionism. In addition, China would have to slow its growth to reduce its level of “excessive leverage” in order to avoid “a hard landing.” Plus, emerging markets can get hurt by a double whammy of trade wars and dollar-strengthening.
- In the event of a correction, “the risk of illiquidity and fire sales/undershooting will become more severe.” That could result in high-frequency/algorithmic trading that produces “flash crashes” which could hurt exchange-traded and dedicated credit funds.
When you add it all up, it means that rather than moving forward with the forecasted hike this December and four in 2019, the Fed will hike less. Last Thursday provided a powerful clue about the Fed’s likely direction.
After plunging 800 points Tuesday, markets were sinking like a rock again Thursday, mostly on the trade war news mentioned earlier. But late in the day it all turned around after The Wall Street Journal reported the Fed is mulling whether to “signal a new wait-and-see mentality” on interest rates at their upcoming meeting in less than two weeks.
Thursday’s rally only reinforced how much the stock still depends on the Fed. The fact is that markets remain addicted to low interest rates and central bank credit. But that just keeps the Fed trapped in a catch-22.
It wants to “normalize” rates as much as possible after years of heavy support to the markets, but it’s now seeing how markets react without that support.
The Fed can tolerate weakness in the stock market, but it fears a complete collapse, which is a very real possibility. So Jerome Powell is between a rock and a hard place. Keep the bubble going, which only prolongs the day of reckoning and makes it worse, or withdraw support and risk a crash.
For now, he’s more worried about a crash. The Fed is realizing that economic growth is slowing and that raising rates too much, too quickly, could spook the markets at a critical time and cause a recession.
That’s why you should expect more dovishness to come from the FOMC meeting on Dec. 18-19, which will lift markets into year-end. You can also expect the Fed to proceed very cautiously next year.