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Slowing Growth Means More Aggressive Fed Easing
09/04/2019 9:10 am EST
While analysts debate whether or not the Fed will move in September, the numbers may be forcing their hand, notes Landon Whaley.
The Federal Reserve’s Open Markets Committee (FOMC) meeting minutes from July 31 released on Aug. 22, were quite telling. The fed noted: “Most participants viewed a proposed quarter-point Fed funds rate cut as part of a recalibration of the stance of policy — or mid-cycle adjustment — in response to the evolution of the economic outlook over recent months.” This “mid-cycle adjustment” belief was perpetuated in public statements made by various Fed Presidents while in Jackson Hole as week as Fed Chair Jay Powell immediately following the meeting.
Folks, there is nothing “mid-cycle” about what’s happening economically in the United States.
Growth is in a death spiral, as evidenced by a wide array of data sets that are deteriorating at an accelerating rate — case in point, the latest Markit Manufacturing PMI.
The August data slowed for the seventh time in the last 10 months, hitting a contraction-worthy 49.9. August was also the worst Markit Manufacturing PMI reading (and the first contraction) since September 2009. This data set is forecasting a likely contraction in the ISM Manufacturing PMI (reported this coming Thursday), and if that occurs, the Fed’s playbook is straightforward.
Historically, once the ISM contracts (reading below 50), the Fed engages in multiple rate cuts. On average, they cut five times, but they cut an average of eight times when the U.S. enters a recession post-ISM contraction. Of course, the Fed is ahead of the game by cutting already in July.
From a micro perspective, have you seen Q2 corporate earnings? Of the 497 companies in the S&P 500, 493 have reported aggregated earnings growth of 1.6%. Keep in mind that it was just nine months ago when earnings hit a cyclical peak of 24.2%. Talk about taking the elevator shaft on the way down. Not to mention that five of the 11 S&P 500 sectors are experiencing an outright contraction in earnings growth: Energy -5.0%, materials -8.2%, consumer discretionary -1.5%, consumer staples -1.4% and technology -6.9%. Of the six remaining sectors with positive Q2 earnings growth, every single one saw earnings growth slow from Q1 2019.
The bottom line is both the macro and micro U.S. outlook is confirming that there is nothing mid-cycle about the current Winter Fundamental Gravity.
That said, we’ve got a battle of forecasts between the Fed and investors. On the one hand, the Fed thinks the U.S. economy is mid-cycle and that they are not in an easing cycle. On the other hand, markets are currently pricing in approximately 100 basis points of cuts over the next 16 months. Guess what? They are both dead wrong.
No matter what sound bites come out of the Fed, you can bet there are more rate cuts coming. But the markets are wrong too because the Fed isn’t stopping at 100 basis points— they are wrong also because it is not good news. This newest rate cut cycle won’t stop until Fed Funds hit 0%.
Yep, I’m calling my shot: there will be multiple rate cuts between now and December 2020 and the Fed won’t stop until rates are zero bound once again. Trade accordingly.
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