Jerome Powell Crosses the Rubicon

Mr. Jerome Powell entered this day hung from the hooks of a mighty dilemma.

Should he deliver another rate hike… or hold steady?

In two opposite directions he was yanked plenty hard…

His inner lights, his inner mother-in-law, urged him to hike.

GDP expanded an average 3.85% the two most recent quarters, they reminded him.

Unemployment — at 3.7% — plumbs depths unseen in a half-century. Wages are on the upswing.

Loading the scales in favor of a hike was the eager American consumer.

November retail sales jumped 0.9% — a Reuters poll of economists had forecast only 0.4%.

In all, an accelerating economy justifying a foot on the brake.

Bloomberg in summary:

“These conditions speak of an economy at full capacity and don’t square with the current benchmark interest rate of just 2.25%.”

Bank of America CIO Michael Hartnett took the business one further.

Should Powell not hike today, he counseled, a stock market rout would ensue.

“What does the Fed know?” would be the market’s response.

A recession would be the answer.

Thus, Hartnett feared a nay would “prompt U.S. stocks to join the global bear market.”

There, in a walnut shell, the aggregated case for a rate hike today.

But from the opposite direction, Wall Street — and the president — pulled Powell violently.

The stock market rests precariously upon a teeter-totter as things stand. Another rate hike may tip it right over, they warn.

And another rate hike could take the oomph out of the economy.

There is justice in their argument…

The Dow Jones has lost some 3,000 points since early October. The S&P and Nasdaq have been similarly trounced.

And half the S&P trades in bear market country.

Are these conditions that warrant a rate hike?

No, says Bloomberg — not if history is a guide:

It’s exceedingly rare the Federal Reserve raises interest rates when stocks are behaving this badly.

In fact, were policymakers to follow through with their widely expected hike Wednesday, it would be the first time since 1994 they tightened in this brutal a market. Right now the S&P 500 is down over the last three, six and 12 months, a backdrop that has accompanied just two of 76 rate increases since 1980.

And the United States economy?

GDP has been expanding, yes — but the trend is down: 4.2% for the second quarter, 3.5% for the third and fourth-quarter GDP estimates come in at roughly 2.4%.

And most 2019 projections range between 2–2.7%.

Meantime, first-quarter business investment expanded at a roaring 11.5% clip. By the third quarter… it was reduced to a sickly 2.5%.

Furthermore, the credit markets have ground to a standstill… like a seizing engine.

And where — exactly — is inflation? asks the anti-rate hike crowd. The Federal Reserve cannot even swing a lowly 2%, they moan.

And it wants to hike rates?

Atop it all the global economy has caught a flu — a contagious flu.

Explains renowned hedge fund manager Stanley Druckenmiller in TheWall Street Journal:

Global trade growth also slowed markedly, running about one-third lower than earlier in the year. Growth in some important economies, like China, is significantly weaker. No ocean is large enough to insulate the U.S. economy from slowdowns abroad. And no forecasting model adequately captures the spillovers and spillbacks between the U.S. economy and the rest of the world.

So if you think current conditions warrant another rate hike, critics conclude, you are far off the facts.

Adding to the doomy chorus was a voice with a Queens accent, rising from his residence at 1600 Pennsylvania Ave.:

It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. 

But would Powell listen to the man who appointed him?

Strangely, the stock market was in jolly spirits leading up to today’s announcement.

The Dow Jones was up some 300 points by noon. The S&P and Nasdaq were similarly enraptured.

Were they expecting good news?

Then at 2 p.m., with all eyes centering, the white smoke billowed from the Vatican chimney… and word came down…

A rate hike it wasto 2.50%.

Powell tuned out the whines and put aside all pleas for mercy — including the president’s.

The stock market took a severe stagger when the announcement crossed the wires. It soon went over… and remained flat on its back the rest of the day.

After being up 300 points at noon, the Dow Jones closed the day down 352 points — a 652-point whiplashing.

The S&P ended 39 points in red; the Nasdaq, 147.

“I think the market reaction to all of this is the Fed is going to overdo it,” says James Paulsen, chief market strategist at Leuthold Group, adding:

“How else can you look at this than it just smells, at a minimum, like a really big slowdown in the economy coming, maybe even something worse.”

Mr. Powell held court at 2:30 in explanation of the decision.

His statement carried a noteworthy revision concerning the “neutral rate.”

As we have explained previously, the neutral rate neither stimulates nor depresses.

Hence it is neutral.

Rates stimulated for a decade. But no longer.

“Policy at this point does not need to be accommodative,” said Powell today. “It can move to neutral.”

The Fed concluded in September that the neutral rate ranged somewhere between 2.8% and 3.0%.

But today it claims the neutral rate may be as low as 2.5%.

Thus, by its own telling, the Fed concedes it is hard against the neutral line.

But as we have discussed recently, today’s rate hike may have actually crossed over the neutral rate.

You can see trouble is on tap once the fed funds rate (blue) crosses the neutral rate (red) — at least since the early 1980s:

Don't Cross the Neutral Rate!

You can also see that the blue line is presently rising past the red.

The record shows something usually snaps six–12 months after the Fed crosses the neutral line.

The arithmetic therefore puts June 2019 on watch — if the theory holds.

But Mr. Powell’s statement today contained a message perhaps even more distressing for markets.

Answer tomorrow…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning