FINANCIALLY SPEAKING Fed rate cut not enough

For the second time during the latter half of 2019 the Open Market Committee of the Federal Reserve, the body that determines monetary policy, has decided to reduce the rate of interest that banks charge each other for overnight loans by 0.25% to a range of 1.75% to 2.00%.

The first 0.25% cut came after the Fed meeting that concluded July 31.

Cited within their policy statement released immediately after the conclusion of their meeting this past Wednesday was their belief that “information received since the Federal Open Market Committee met in July indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low.”

To that we respond – hardly reasons to cut.

However, the statement went on to note that “although household spending has been rising at a strong pace, business fixed investment and exports have weakened. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent.”

We have little or no issue with the prior two paragraphs outlining the realization that although the domestic economy remains relatively strong, it has been buffeted by weakening global economic demand as well as uncertainty over the trade and intellectual property tensions between the United States and China.

That said, we do have an issue with the magnitude of the cut. We believe the Fed should have reduced interest rates by twice as much as they did or by 0.50% rather than 0.25%.

We cite three specific reasons outlining our rational for a fifty basis point cut (1 basis point equals 1/100 of a percent).

Number one, the Fed’s dual mandate which seeks to “foster maximum employment and price stability” was signed into law as part of the Federal Reserve Reform Act on November 16, 1977. The United States had for years been wading through a lengthy period of rampant inflation as a result of a run-up in the price of energy as well as instability in the labor market.

Evidence of this can be found in retail inflation data as measured by the Consumer Price Index (CPI) which had risen by 6.7% over the preceding twelve months even while the unemployment rate stood at a historically high 6.4%. It is our belief that given the economic conditions outlined above, the legislation enacted might no longer allow the Fed the necessary flexibility when making policy adjustments.

Number two, during 1977 the United States imported approximately 45% of domestic energy consumption. Today we are a net exporter. This drastic change allows for greater predictability when determining the cost of consumers filling their gas tanks or for heating their homes.

We believe that widely fluctuating energy prices in the United States are most likely a thing of the past. This also helps to dampen inflation expectations.

Number three, Amazon as well as other advances in technology has helped to keep increases in the cost of components to production as well as the cost of labor under control and therefore has muted inflation.

By continuing this process of incrementalism or “death by 1,000 cuts,” we believe the Fed runs the risk of setting the U.S. economy on a disinflationary or even a deflationary course, most likely resulting in poor economic growth. A more aggressive Fed would have had a better chance of steepening the yield curve, thereby jolting consumers out of their current purchasing habits and perhaps increasing demand for homes as well as other big ticket items.

It is also likely that business fixed investment would also increase.

It is time for the fed to partially shake loose this dual mandate and begin to fear creating a deflationary environment as much as it has historically feared an inflationary one.

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