The Real Reason the Fed Cut Rates

Why precisely did the gentlemen and ladies of the Federal Reserve lower interest rates yesterday?

(Here is one hint: It was not to “stimulate” the economy.)

And did they slash rates not 25 basis points — but effectively 40 basis points?

That is, does yesterday’s rate cut nearly count double? And why does it matter so?

Questions, questions — so many questions.

Today we fare forth, gumshoes on feet, sleuth bag in hand… in search of answers.

First to the markets…

Stocks Rebound — Until…

Jerome Powell’s post-announcement comments knocked stocks flat yesterday.

He declared the rate cut a mere “midcycle adjustment.” It did not imply additional cuts whatsoever, he insisted.

The stock market was expecting Powell to telegraph further easing.

It therefore staggered badly on his comments… and took the count.

It regained the vertical this morning. But by afternoon it was horizontal again, freshly pummeled.

This time President Trump landed the clout.

He announced 10% tariffs on an additional $300 billion of Chinese goods. The wall goes up Sept. 1.

The Dow Jones ended up losing 281 points on the day. The S&P gave back 27 points, the Nasdaq 64.

After wallowing early, safe haven gold gained $18.10 on the day.

And after starting the day above 2.0%, the 10-year Treasury yield plunged to 1.89%.

But why precisely did Jerome Powell and his understrappers cut rates yesterday?

Goodbye “Data-dependence”

They forever howl that they are “data-dependent.”

Well then, come camp down with the data…

Unemployment runs at 50-year lows. And GDP jogs along at a passable 2.1%.

What about inflation?

The Federal Reserve sweats, heaves, groans in pursuit of 2% inflation.

Look at the latest data.

The Personal Consumption Expenditures Price Index (PCE) — the Fed’s preferred inflation metric — has risen at an annual 2.2% three months running.

Core inflation is up 2.5%. Producer prices are likewise on the jump, up 2.3% this past year.

Mr. Powell has raised rates when inflation simmered lower.

And the stock market — incidentally — trades at record heights.

Put the numbers together, one atop the next or side by side.

If the Federal Reserve is so data-dependent… where are the data that shriek for a rate cut?

We refer to official numbers of course. We disbelieve many of them — by many of them we mean all of them.

But these somber men and women take them very heavily.

How then do they square this impossible circle?

We must conclude yesterday’s cut made a cruel jest of the Federal Reserve’s “data-dependence.”

A fellow might even argue for a rate hike under the circumstances.

“The Most Pointless Rate Cut in Fed History”

Moneyman Bill Blain has in fact labeled yesterday’s rate cut “the most pointless rate cut in Fed history.”

Fed history takes in a vast territory. Why the most pointless?

“Easing rates in a ‘healthy’ economy pretty much at full employment with a ‘favorable’ outlook, where the only real problem is massively inflated financial asset bubbles.”

Why then the rate cut?

Yards and yards of explanation have come rolling from the financial media.

Some accept the Federal Reserve at its word. The United States economy may be an economic dynamo, they argue.

But the world beyond its shores languishes in doldrums. A rate cut forms a protective cushion against global weakness.

Did Powell Give Into Trump?

Others suggest Jerome Powell yielded to Mr. Trump’s repeated bludgeonings, that politics fetched him at last.

CNBC’s Steve Liesman even intimates the Federal Reserve might have feared for its very existence — if it did not succumb:

Think about what happens when a person gets up at a rally and starts railing against the Federal Reserve and starts to create what could lead to congressional pressure on the Fed and then you could imagine that there could be support for a different system. I think they think there’s a lot of political downside risk to getting this wrong.

But of course, the president yelled for a “large” rate cut. He did not receive one.

If Powell expected his pinprick rate hike to win Trump over… he badly missed fire.

“As usual, Powell let us down,” lamented the president.

What, therefore, did yesterday’s rate cut accomplish?

Powell only appeared confused, rudderless… clueless.

We have no doubt he is all of them — and more.

But there are appearances to maintain.

Then why, again, the rate cut?

Might it have been the next shot in the currency war?

That is the answer, argues Jim Rickards.

“It’s All About Currency Wars”

Here Jim holds Powell upside down and shakes the answer from his pockets:

On the surface, a rate cut didn’t make much sense. Unemployment (officially) is at 50-year lows and the economy is chugging along: 2.1% second-quarter growth isn’t great, but it’s not terrible, either.

To justify the move Powell cited “the implications of global developments for the economic outlook as well as muted inflation pressures.” It’s true, the global economy is slowing by many measures. And inflation is still short of the Fed’s sustained target rate of 2%. But the numbers have improved a bit. The Fed has raised rates with similar inflation numbers.

But this rate cut has almost nothing to do with “stimulus.” It’s all about currency wars. The Fed wants to cheapen the dollar. The currency wars started in 2010 and are still going strong.

Jim finds support in The Wall Street Journal. From which:

The European Central Bank’s policy rate, at minus 0.4%, is already nearly three percentage points below the Fed’s. And last week ECB President Mario Draghi strongly hinted it will soon go further into negative territory. Fed officials have concluded they cannot permit U.S. rates to deviate too far from their foreign counterparts’. So even though the U.S. economy is in much better shape than Europe’s, the ECB is helping to force the Fed’s hand.

Perhaps they have hooked onto something here. The Federal Reserve is simply keeping pace in the currency war.

Yesterday’s rate cut was 25 basis points… officially.

But did Jerome Powell effectively heave up a 40 basis point cut?

“Have no Fear, Liquidity Is Here”

Recall, quantitative tightening was being retired in September. But yesterday Mr. Powell announced an immediate halt. The August and September rounds are out.

The liquidity scheduled to come draining out of the financial system in August and September therefore remains on duty.

Estimates place QT’s impact at seven basis points of tightening per round.

With August and September QT shelved, a combined 14 basis points of liquidity stay on.

Add it to yesterday’s 25 basis points… and you have in essence a 40 basis point slashing.

Notes analyst T.J. Hayes by way of

So between now and the next Fed meeting (September 2019) we got a 25 basis point cut PLUS seven basis points equivalent of easing in August and seven basis points of easing in September, yielding the equivalent of about 40 basis points of relief or an UNWINDING of around 10% of the tightening that was put into place over the past few years.

Add two additional rate cuts to the end of QT. This Hayes fellow estimates markets may drink in 159 basis points of liquidity these next 12 months.

“Have no fear, liquidity is here,” he concludes.

Just so.

But here is our fear…

That this additional liquidity will inflate existing asset bubbles to preposterous dimensions — stocks, bonds, real estate, to note some.

More Wall Street. Less Main Street

More and more money will go chasing after riskier and riskier assets.

We will see more debt. More speculation. More financial engineering. More delirium…

Conversely, less market discipline. Less capital formation. Less productive investment. Less saving.

That is, we will get more Wall Street. And less Main Street.

Most of all… we fear an even larger crash when the tab comes due…


Brian Maher
Manager editor, The Daily Reckoning

The Daily Reckoning