Fed to cut, or signal cut, as emerging markets rejoice

Published 19.06.2019 18:21
Updated 19.06.2019 18:22

The Federal Reserve's Open Market Committee (FOMC) announced their decision late Wednesday on what to do with the benchmark U.S. interest rate, the "Federal Funds Rate." Last year nearly all economists and Fed watchers alike agreed that the Fed would most likely raise rates three-four times in 2019 and another three-four times in 2020. I disagreed. The Fed would be hard pressed to raise rates at all in 2019 and would more likely cut rates, I argued, after the November dot plot was released. At the time every FOMC member, the body that votes to alter the interest rates, argued just the opposite. Or did they?

As I write this column on Wednesday, hours before the official announcement, let me predict for you what is going to happen. It's an election year; U.S. President Donald Trump has kicked off his re-election campaign as have the democrats. President Trump's pick to chair the Fed now calls the shots at the FOMC and U.S. financial markets are at near all-time highs. This rally in equities is a direct result of the Fed's nodding to markets that it will cut much sooner than expected. I wouldn't be surprised if the Fed either cut at this meeting, which we'll know by the time this article goes to print late Wednesday night, or signals that a cut is on the way. Either way markets will rally.

The market rally will be great for global markets. Foreign currencies will rally, including emerging markets. The debt burden of companies and households will ease, if only slightly initially. It will be like a much anticipated rain in the Sahara. But like desert rain, the water will quickly run-off and as the soil dries, more rain will be need to sustain life. This is when the Fed will have to cut again in September. Why?

While all appears to be great now, under the surface, there are major cracks in the global financial system. Leverage has returned to pre-Great Recession highs, income growth lags employment growth, and income inequality is only growing. A slowdown in consumer consumption now, just as the 2020 election cycle picks up, would be a kiss of death for President Trump's chances. This is the only obstacle he has to getting re-elected. Trump's pick won't let that happen.

Whatever you may think of Trump, he's widely liked in U.S. business circles. Jingoism is great for business. He's throwing around U.S. weight wherever he goes and while in the long-term this will be bad for the U.S., CEOs get paid by quarterly performance, in the long-run we'll all be dead. So why would the Fed appear to argue for rate hikes even as they knew they would most likely cut in 2019? Because they have to. Their comments are meant for their audience, financial markets. Signaling cuts before a slowdown signals the slowdown itself. Signaling rate hikes is like a runner pushing through the pain before she needs a break. Now she needs a break and the Fed is here not a moment too soon.

Expect a quarter point cut today or by September and expect a revision of the dot plots of FOMC members. These steps may very well allow the rally in the U.S. to continue as emerging markets refinance debts and rejoice.

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