The Federal Open Market Committee (FOMC) reduced the central bank rate by 0.25% yesterday. The Dow closed down 334.75 points (1.22%) which reflects the disappointment that the cut wasn’t 0.50%, with promises of more stimuli to follow.
The market fully recovered that loss early today but Trump’s announcement of additional tariffs of 10% on over $300 Billion of Chinese exports caused that gain to evaporate to a loss of another 280 points (1.04%).
The FOMC is walking a delicate tightrope. If they had made a bigger cut and promised more stimuli, investors would have interpreted that as confirmation that the economy is in worse shape than is understood.
The question period after the announcement was an amazing display of circumlocution. I found it quite understandable because the US economy has some pockets of weakness that are concerning but the indicators are not universally bad.
I will give them the benefit of the doubt for the time being but I suspect that the 20% market decline in late 2018 increased pressure from Mr. Trump to cut rates. Trump does not want a strong US currency or falling markets.
He has been trying to talk down the US currency.
The European and Asian economies are clearly in a slowdown, which will impact the US in due course. This cut in rates could be the FOMC’s response to the risk from external weakness. The European Central Bank is promising to join in with more stimuli. Their rates are already negative, which is killing the European banks.
The FOMC denies that more cuts will be automatic unless the economy needs more help. I don’t believe that statement, because there has never been just one cut and done through history.
They seem to be trying to get out of the way of the financial markets, rather than promise to come to the rescue of investors if markets decline. This is probably the most important message because investors have been rescued from falling markets since 2009 and have been expecting this to continue.
Currently, short-term bond yields, have fallen below the Fed’s new rate. Clearly, the bond market is anticipating more rate cuts.
All-in-all, the rate reduction is not meaningful. In the meantime, we are implementing a significant adjustment to our portfolios with the expectation the change may provide a solid gain over the next few months. There is no guarantee of course but it is a strong likelihood.