Monthly Markets Memo - June 2019

World Money Small.jpgby Dan Zalipski, CFA 

High Expectations for Lower Rates?

Trade issues continued to drag on the market over the past month as President Trump opened a new front against Mexico.  In an effort to curb illegal immigration, President Trump threatened to place 5% tariffs on all imports from Mexico with a plan to scale the tariffs up to 25% by October.  This caught the market by surprise and added fuel to the equity market sell-off that began earlier in May with the escalation of trade tensions with China.

The concern was that tariffs on imports from Mexico would rapidly impact the U.S. consumer (more so than China) as prices on goods such as automobiles and agricultural products would begin to increase.  Fortunately, the tariffs on Mexico did not go into place as a deal was worked out in which Mexico would take a larger role in attempting to slow the flow of migrants from Central America to the U.S.  Unfortunately, the threat or use of tariffs to coerce policy changes from trading partners is likely to continue contributing to market volatility in the near-term. 

The Fed took notice of the recent trade-related actions and their impacts on the economies and markets.  In early June, at the Conference on Monetary Strategy, Tools and Communications Practices, Federal Reserve Chairman Jerome Powell acknowledged the recent developments on the trade front.  “We do not know how or when these issues will be resolved,” Powell said. “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.”  The market surged as investors interpreted the news as the Fed’s willingness to cut interest rates to extend the current expansion. 

Despite what the Fed has stated, investors counting on a rate cut may be getting their hopes up.  The Fed’s dual mandate is one of price stability (managing inflation) and to maximize employment.  We are long from a world with run-away inflation, and unemployment is near a 50-year low.  Furthermore, the Fed typically reserves interest rate cuts for recessionary environments as a means to stimulate the economy back to expansion.  Looking past the market volatility, the U.S. economy continues to demonstrate robust strength.  Specifically, the latest NFIB reports (National Federation of Independent Business) exceeded expectations.  Small-business confidence is trending higher, and more firms are planning to increase hiring and capital expenditures.  They have also raised their sales and profit forecasts.  Wall street may be nervous, but main street is optimistic.  Should the Fed cut rates now, they may find themselves unable to meaningfully cut rates during the next recession, limiting their ability to adequately stimulate when it matters most.  The volatility will likely continue, but with the Fed simply acknowledging the current situation, investors may breathe easier believing they have an ally in the Fed.                   

 

…recovery out of the next recession is likely to be uninspiring and uneven as the Fed has little room to cut rates relative to the past…” 
Joseph Lavorgna, Natixis Chief Economist

 

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