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A Peculiar Time for Additional Stimulus

August 5, 2019

S Rossi 2014

A Peculiar Time for Additional Stimulus

By Stephen A. Rossi, SVP, Senior Equity Strategist – CNB Wealth Management

Published on August 5, 2019 in the Rochester Business Journal

In hindsight, it seems that last December might have been a reasonable time to consider additional economic stimulus in the form of a Federal Reserve Bank interest rate cut. By Christmas of 2018, the U.S. government was in the midst of a 35-day shutdown that lasted from December 22nd to January 25th. Our country had imposed tariffs of between 10 and 25% on $250 billion of Chinese imports, and China had responded by imposing retaliatory tariffs on $50 billion of U.S. exports to China. Fears over additional tariffs, slowing global growth, slowing corporate profits in the U.S. and a Federal Reserve Bank bent on raising interest rates three times in 2019 (for a total of 12 rate hikes since 2015) and two additional times in 2020 had spooked investors. As a result, and on an intra-day basis, the Dow Jones Industrial average fell almost 17.5% from November 8th to December 26th and approximately 19.5% over the entire fourth quarter of 2018. Market pullbacks of 20% or more have typically been associated with recession but, as we know, the Fed chose not to take any action at that time and the current U.S. expansion has yet to end in recession.

The first two quarters of 2019 have been markedly different from the fourth quarter of 2018. The U.S. government is up and running again (at least until September), the trade war with China continues, but negotiations are progressing and, although the Trump Administration followed through on its threat to raise tariffs from 10% to 25% on $200 billion of Chinese imports, the imposition of further tariffs on an additional $300 billion of Chinese imports (essentially all that remain) has been delayed. More significant is the fact that the Fed has done a complete one-eighty in terms of its policy stance on monetary stimulus. Having gone from a proposed three rate hikes in 2019 and two additional hikes in 2020 to a posture of no interest rate hikes (period), the Fed has as recently as mid-June also signaled its willingness to entertain rate cuts, and perhaps several of them.

The timing of the Fed’s proposed rate cuts would seem peculiar to most and there are several reasons why. U.S. GDP growth over the last four quarters has been 3.1% (Q119), 2.2% (Q418), 3.4% (Q318) and 4.2% (Q218). This compares to a historically normal rate of growth of between 2.5% and 3%. According to data from Northern Trust through May of this year, the composite of leading economic indicators is either break-even or positive over rolling one-month, three-month and twelve-month periods. Inflation is low, unemployment is low, gas prices are low and, with 43 of the S&P 500 companies having reported Q2 earnings as of Wednesday, July 17th, 84% of them have beat analysts’ estimates with an average earnings increase of 8.8%. To boot, average hourly earnings in April were 3.2% higher than a year earlier (the ninth straight month in which wage growth topped 3%), while retail sales were up 3.4% on a year-over-year basis in June (the fourth consecutive monthly advance for this measure of economic vitality). With the consumer driving roughly 70% of the economy, wage and retail sales growth, among other things, have certainly been encouraging.

Notwithstanding the above, measures of manufacturing, non-manufacturing, industrial production and housing have all slowed since - and partially as a result of - the trade war with China and others. In spite of this, all of these measures continue to reflect ongoing growth. Furthermore, manufacturing only accounted for 11.6% of U.S. economic output in 2018 and both consumer and business sentiment continue to be positive. So why is it that the Fed is now entertaining interest rate cuts, as opposed to a simple pause in rate increases, particularly when the economic data is so overwhelmingly positive? The answer may relate to political and economic leverage.

As the U.S. attempts to win concessions from China and others, in an effort to reduce trade deficits and protect the interests of U.S. businesses, it must do so from a position of relative economic strength. That means taking steps to ensure that the U.S. expansion isn’t interrupted in this pursuit, even as constituent groups such as Midwest farmers suffer in terms of the retaliatory tariffs that have been imposed on many of our agricultural exports. As we ratchet up the pressure on those that would seek to take advantage of us economically and make it increasingly uncomfortable for countries like China to continue on with its current trade policies in this regard, it would seem we must do what’s necessary to prolong the current expansion and succeed at leveling the playing field. However, doing so may lead to adverse consequences such as higher inflation and asset price bubbles down the road. Is it a peculiar time for the Fed to be considering additional stimulus, given what we know about the current state of the economy? Yes, and although the Fed claims to maintain independence from Presidential and political pressure in its decision making process, it may be that the greater good of achieving a current fiscal policy goal now outweighs the potential consequences of pursuing a more aggressive monetary policy than might otherwise now be warranted.

To see his column in the RBJ, click here.