July 2019

The Federal Reserve lowered the overnight Fed Fund rate by 25 basis points as expected, at the conclusion of last month’s FOMC meeting.  As is the case following every FOMC meeting, the Fed Chairman gave a press conference with the goal of ensuring market participants understand the thinking of the committee.  Typically, the reporters, most of whom are fixtures in the financial media, toss the Chairman “softball” questions so as to not embarrass him.  At the July meeting Powell wasn’t afforded that courtesy as the media sought to understand what the Fed was trying to accomplish by cutting interest rates with the economy clearly growing strongly.  Was there something that the markets weren’t seeing that worried the Fed and, if so, what was it?  Is this the beginning of a new easing cycle and if so how low would rates need to fall?  Did the Fed intend to drive interest rates into negative territory as has been done in Japan and Europe?  Those were just a few of the questions asked with plenty more of a similar nature.  Why did the Fed bring the “punchbowl” back when the party was still going strong?  As he answered question after question it became clear that Chairman Powell was growing more and more uncomfortable.  He didn’t fare any better in the print media that described the Fed as having been “brow-beaten” into acquiescing to the demands of President Trump.

In addition to cutting the overnight lending rate, the Fed announced that they would begin quantitative easing effective August 1st, several months earlier than they had suggested earlier in the month.  Last week they participated in the 10-year and 30-year auctions.  On Wednesday, the Treasury auctioned $27 billion 10-year notes with the Fed buying an additional $17.6 billion.  Similarly, on Thursday when the Treasury auctioned $19 billion 30-year bonds, the Fed bought an additional $12.39 billion.  It occurs to us that their reporting is a bit disingenuous in that only the publicly auctioned paper is communicated as the auction amount, when in fact the amount borrowed is much larger.

As though the Chairman hadn’t muddied the waters enough, St. Louis Fed President James Bullard, a monetary policy “dove,” gave a speech in Washington on August 6th, in which his comments were somewhat perplexing.  His said the Fed won’t react to day-to-day market moves and that the committee has already taken trade policy into consideration with regard to monetary policy.  He did say that he wouldn’t rule out future policy changes but that is a far cry from communicating that the Fed is going to again cut rates in September.  But they very well could cut again in September or December because they have confused investors to the point that their next move is anyone’s guess.

Since the rate cut, the bond market has staged a massive rally, with the 30-year bond up nearly 13 points and the yield standing at just above 2.00%.  To put that into perspective, the Core Consumer Price Index rose 2.20% year-over-year in July.  That means that bond investors are destroying wealth by holding a bond that yields less than inflation.  The bond bulls will counter by pointing out that at least the yields are not negative as they are in Japan and Europe.  That argument rests on the premise that the Fed’s policy is less bad than that being pursued by other central banks.  That logic may hold in the short term but ultimately bad policy begets an undesirable outcome.

The drop in yield has prompted a new wave of refinancing as mortgage rates slip below 4.0% for a conventional 30-year mortgage.  Should the refinance cycle continue into the fall, we can expect that the stimulative effect it has on the economy to return.  That’s likely to be supportive for consumption and GDP growth.

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