Interest Rate Cuts – Salvation Or Damnation?

The anticipation and speculation regarding interest rate cuts is almost comical to watch. Scratch ‘almost’. Interested observers are obsessive about the topic in a hilariously funny way. Mainstream media and the pundits always find cause for promoting a possible rate cut no matter what is said. (see Investors Re: Rate Cuts)

The expectation for at least one cut of 1/4 point before the end of this year seems to be nearly universal, so let’s go with that for now. Here are some questions for consideration.

WILL A RATE CUT MAKE ANY DIFFERENCE?

Likely not. The stock market has gone absolutely giddy on the expectation of an eventual cut. The official announcement and implementation of an actual cut in rates might help soothe any anxiety plaguing nervous investors; but, that is about all.

Other markets have priced in a rate cut to the extent possible but, there would have to be more rate cuts evident after that to provide any spark for future gains. One or two rate cuts still leaves interest rates close to forty-year highs.

Any positive effects on economic activity will require a series of cuts more significant in nature than anything gained from a single 1/4 point cut.

WHAT IF RATE CUTS ARE DELAYED OR POSTPONED? 

Investors have been very patient, almost unrealistically so, regarding expected rate cuts. Any further delays might provoke significant selling, particularly in stocks. The risk of a big selloff in stocks exists even if current expectations for a cut are met. Stock prices have already factored in the expected cut, so a single cut before year end is probably necessary for stocks to just maintain their lofty levels. Once an announcement is made, profit taking becomes a strong possibility.

ARE RATE CUTS NECESSARY? 

Some some say yes; some say no. If you believe that intervention by the Federal Reserve in the financial markets is expected and appropriate, your answer more likely would be ‘yes’. Regardless, there is a fundamental argument for keeping interest rates stable or even increasing them further.

The Federal Reserve maintained an interest rate policy of “lower for longer” for four decades. Interest rates were engineered to artificially low levels historically and kept there to the detriment of the U.S. dollar and the financial markets.  The change in interest rate policy was implemented two years ago to help support the U.S. dollar and tame the effects of inflation.

In his testimony before Congress this past week, Chair Powell indicated that progress towards the Fed’s 2% inflation target has been made, but that he is not confident yet that the trend can be maintained. If that is the case, then why are rate cuts being considered now? Moreover, if that level of confidence is confirmed by subsequent lower inflation rates, i.e., success resulting from the campaign to restore interest rates to more historically normal levels, then why should rate cuts be considered at all?

In other words, why go back to the failed policy of the past that created havoc and brought destruction, just because you feel better now?

CONCLUSION

There is one factor that could likely force the Fed’s hand regarding a rate cut. That factor is the alarmingly rapid deterioration in economic activity. The prevalent weakness is showing up across a broad front including retail sales, residential and commercial real estate, durable goods orders, etc. When it gets bad enough for citizens and politicians to complain too loudly, the Fed will give in. Don’t expect any possible rate cuts to have a positive impact, though. The effects will be similar to firing a pistol filled with blank cartridges at a charging grizzly bear.