Federal Reserve Chairman Jerome H. Powell clearly stated the Fed’s monetary policy objectives in his public speech on 2 October 2018:
- Maintain the dual mandate of promoting maximum employment and stable prices.
- Resolutely conduct policy consistent with the Federal Open Market Committee’s (FOMC) symmetric 2 percent inflation objective, and stand ready to act with authority if expectations drift materially up or down.
- Continue the gradual increase of interest rates.
In defense of his third point, Powell said “Our policy of gradual interest rate normalization represents the FOMC’s attempt to take the downside and upside inflation risks seriously. Removing accommodation too quickly could needlessly foreshorten the expansion. Moving too slowly could risk rising inflation and inflation expectations. Our path of gradually removing accommodation, while closely monitoring the economy, is designed to balance these risks.”
Powell also admitted, “There are, of course, myriad other risks. To name just a few, we must consider the strength of economies abroad, the effects of ongoing trade disputes, and financial stability issues.”
The Fed should seriously consider those “myriad other risks,” and others proffered below, and NOT carry out their current plan to raise interest rates for the fourth time this year in December.
Removing policy accommodation (i.e., raising interest rates) more slowly and pushing the economy to determine if the new natural rate of unemployment is lower than its current historic low of 3.7% would be the smarter way to go.
Here is our rationale …
STOCK MARKET
The stock market is a predictor of future value. So why did the market (Dow Jones Industrials and S&P 500) nosedive so precipitously immediately following the Fed Chairman’s speech on October 2?
While this correction has done significant damage to the value of American’s 401-k plans, it should mitigate the Fed’s concerns about financial instability and a stock market bubble.
GDP
Gross Domestic Product growth is significantly above the Obama era’s lackluster performance of < 2%, but the most recent 3Q18 numbers are down from the 2Q and should temper any concerns about runaway growth.
UNEMPLOYMENT & CORE INFLATION
The U.S. rate of unemployment is on a long downward trend and core inflation (less energy and food prices) is in a long stable trend around the Fed’s 2% target.
INTEREST RATES
Low interest rates make investment in developing countries more attractive. High rates make investment outside the United States less attractive. As the United States returns to higher interest rates, investment in the United States becomes more attractive and the rate of investment in developing countries falls. However, higher interest rates (relative to inflation and other country’s rates) discourage domestic economic expansion and job creation.
The U.S. Federal Reserve raised its target range for the Fed Funds Rate by 25bps to 2% to 2.25% (vs 2.17% inflation today) during its September 2018 meeting. Policymakers see one more rate hike this year, 3 increases in 2019 and 1 in 2020.
Meanwhile, the EU has been holding their Deposit Facility Rate (equivalent to the US Fed Funds Rate) steady since early 2016 at -0.4% (vs 2.1% inflation today), and they don’t plan on increasing it at least through next summer.
China has been holding their interest rate steady for nearly two years at 4.35% (vs 2.5% inflation today).
We need to make sure we’re not putting ourselves at a competitive disadvantage with our main trading partners.
CURRENCY EXCHANGE RATES
Interest rates also affect the value of currencies, a higher US interest rate increases the value of the domestic currency and decreases the value of foreign currencies.
In 2018, the US dollar has gained 9.6% against the Euro and 11.2% against the Chinese Yuan.
EXPORTS
The stronger US dollar hurts exports, and curbs growth and jobs at US companies, while increasing our already high trade imbalances with the EU and China.
TRADE TENSIONS
As the Washington Times recently reported, “Love him, or hate him, you’ve got to hand it to Donald Trump. His trade and tariff strategy — risky as it is — seems to be working.” President Trump first worked out a USMCA deal to replace NAFTA with Mexico and Canada, and now he’s moving on to do the same with the EU. He’s also pursuing new fair trade arrangements with South Korea and Japan. At the end of the day, there’s a good chance all of these new trade arrangements will be better deals for American firms and workers.
The Trump Administration is also using tariffs to land a new trade agreement with the biggest trade deficit fish — China. But since the U.S. imposed $250 billion in tariffs on Chinese goods, and Beijing retaliated with $110 billion on U.S. exports, negotiations with China are at a standstill. According to the WSJ, “U.S. negotiators have given their Chinese counterparts an eight-point list of demands, ranging from halving the $376 billion trade deficit to curtailing much of China’s subsidies for high-tech industries.” Trump says, “China wants to make a deal. China would love to make a deal. I don’t think they’re ready yet.” Trump has threatened to add more tariffs if China doesn’t address the United States’ main concerns, including intellectual property theft. Trump says “the bilateral trade between the US and China is not fair and balanced.”
While we believe Trump’s hardball tactics have a good chance of succeeding, it will take time … a lot of time. The Chinese think in terms of millenniums, we think in terms of months. Consequently, while the Fed must act independently of the Executive Branch in setting monetary policy, it must consider these likely long duration but in the end worthwhile trade skirmishes in concert with their mandated objectives.
GLOBAL GROWTH
The Guardian reported in a September 2018 article that the Organisation for Economic Cooperation and Development (OECD) has warned “the expansion in the global economy may have peaked.” It cut its growth forecasts for an array of rich and developing countries. The Paris-based OECD called for “immediate action to halt the ‘slide towards protectionism,’ as trade tensions were already having an impact on confidence and investment.” The OECD projects global growth to settle at 3.7% in 2018 and 2019, marginally below pre-crisis norms, with downside risks intensifying.
The Wall Street Journal reported in an October 2018 article that the International Monetary Fund (IMF) “lowered its forecast for global economic growth this year and next, citing rising trade protectionism and instability in emerging markets.” The IMF said, “The global economy will expand 3.7% this year, down from its April estimate of 3.9%. Risks about which the Fund had warned this year — such as rising trade barriers and a reversal of capital flows to emerging market economies with weaker fundamentals, and higher political risk — have become more pronounced or have partially materialized.”
We believe the Fed is right to consider what appears to be slowing global economic growth when deciding whether to continue raising US interest rates.
INVESTMENTS
Higher US interest rates are also making it harder for consumers to make investments in homes and cars.
Housing has fallen 4%, and investment in commercial buildings fell 7.9%. This decline should actually reduce the Fed’s concerns about the risks of another housing bubble.
Despite soaring consumer confidence, higher interest rates have caused vehicle sales to decline 6.5% in the past year.
POLITICS
If the Democrats take over the House of Representatives on November 6, and presently there is a 84% chance of that happening, the Fed must factor into their future interest rate decisions the inevitable Democrat-led increases in regulations and taxes and the equally inevitable drag on the economy.
So, Fed Chairman Powell, please take these myriad risks into consideration when determining the best course of action for balancing economic growth, employment and inflation.