Capital Markets

The Fed Speaks: ‘A Mid-Cycle Adjustment to Policy’

The Fed Speaks: ‘A Mid-Cycle Adjustment to Policy’
3 min 46 sec

The U.S. economy continued its now-record expansion in the second quarter with a 2.1% gain in GDP, slower than the robust 3.1% in the first quarter but well ahead of expectations. Consumer spending rose 4.3% in the quarter, supported by solid gains in the job market and disposable income growth of 5% in each of the first two quarters of 2019. Offsetting the gains in consumption were hits to GDP from exports, non-residential business investment, residential investment, and a drawdown in inventories. The economic news for the U.S. during the quarter was largely good, and better than the headlines would lead us to believe. Yet the Fed proceeded with a widely anticipated (and clearly signaled) interest rate cut in July, lowering the Federal Funds rate target by 25 basis points.

How did we get to a situation where the expansion continues but the Fed acts to cut rates? In classic Fed-speak, the announced reasoning is “a mid-cycle adjustment to policy.” To be fair, while the job market and overall GDP data are coming in solid for the U.S., the global economy is clearly showing signs of slowing, and the uncertainty stemming from trade tensions is top of mind. Chairman Jerome Powell noted three reasons for the rate cut: (1) to insure against downside risks from slowing global growth and trade tensions; (2) to mitigate the effects those factors are already having on the U.S. outlook, even if they haven’t shown up in the data; and (3) to enable a faster return to the Federal Reserve’s symmetric 2% inflation target.

It is important to note that the Fed made clear this July rate cut is not likely to be the first in a series. After initial confusion, the markets simply interpreted this Fed comment as fewer rate cuts this year than were previously priced into bond yields.

Key to the Fed’s perceived latitude to lower rates is the persistent surprise of low inflation. After breaking through the Fed’s 2% target in 2018, inflation has once again subsided. Headline CPI rose 1.6% in June (year-over-year), dragged down by a 3.4% decline in energy costs. In fact, core CPI (less food and energy) rose 2.1% over the past 12 months, pushed up by the rising cost of shelter, apparel, and used vehicles. While annual wage gains have moved above 3% for the first time since the Global Financial Crisis (GFC), wage pressures have yet to show up in headline inflation. The impact of tariffs on consumer prices has not affected the broad CPI data, as the tariffs to date have been narrowly targeted.

Quarterly Real GDP Growth

Foreshadowing the expected slowdown in the U.S. economy is the Purchasing Managers’ Index (PMI), a forward-looking measure of business expectations for manufacturing demand and production. The mid-year 2019 reading of the PMI hit 50.6, very close to the line dividing expansion from contraction (50), and the lowest reading since 2009. Producers cite the twin worries of slowing global growth and trade tensions; the 5% drop in exports and the softening of business spending in the second quarter data certainly support these concerns. Other concerns about a material slowdown to GDP growth include the waning impact on domestic spending that has come from rising stock prices and fiscal stimulus since the GFC. Further concerns include the effects of potential new tariffs, and the slowdown in inventory accumulation. The U.S. economy is also approaching capacity constraints as the expansion reaches into record territory. Unemployment has hit a generational low of 3.6%; at some point firms’ difficulties in finding new and replacement staff will weigh on overall workforce growth.

The nine interest rate hikes enacted by the Fed through 2018 raised the cost of borrowing for both businesses and consumers, and while the reversal of Fed policy since January halted the trajectory of rates, the impact of the increases since 2016 is still working its way through the economy. Higher mortgage rates slowed housing markets, pulling existing home sales down by more than 10% over the course of 2018. Rates for 30-year mortgages have fallen by more than 110 bps since November 2018, and home sales have bounced back since the start of the year, but the recovery has been uneven, concentrated in the South and the West. Investment in new homes, as measured by permits, began slipping in 2018 and is still down more than 10% (year over year) through June. New residential construction, restricted in many locations by supply and cost factors, has lagged the pace set in typical expansions since the GFC.

Posted by

Share on facebook
Share on twitter
Share on linkedin
Related Posts
Macro Trends

Amidst the Wreckage, Silver Linings Are Visible

Kristin Bradbury
Kristin Bradbury assesses the global economy in 4Q22 and what inflation, interest rate hikes, COVID, and the Ukraine war mean for institutional invest...
Macro Trends

Mayhem Continues in the Capital Markets

Jay Kloepfer
Jay Kloepfer analyzes the U.S. and global economy in 3Q22, marked by volatile markets and inflation fears.
Macro Trends

Global Challenges Wreak Havoc on Economies

Kristin Bradbury
Kristin Bradbury examines the issues facing the global economy in 3Q22 and what they mean for investors.
Macro Trends

PCE and CPI: What’s the Difference?

Fanglue Zhou
Fanglue Zhou explains how CPI and PCE differ and why the Fed prefers the PCE.
Macro Trends

Recession—Are We There Yet?

Jay Kloepfer
Jay Kloepfer analyzes the U.S. and global economies in 2Q22 and explains why we are not technically in a recession.
Private Markets

The Fading Unicorn: How Volatility, Inflation, and Rate Hikes Impact Venture Capital

Ashley Kahn
Ashley Kahn explains the impact of rising inflation, interest rate hikes, and market volatility on venture capital portfolios.
Macro Trends

Bubbles Bursting Everywhere

Janet Becker-Wold
Janet Becker-Wold explains how recent bubbles inflated and what their popping means for institutional investors.
Macro Trends

Global Challenges Mount

Kristin Bradbury
Kristin Bradbury analyzes the global economy in 2Q22.
Private Markets

Rising Interest Rates Spur Look at Structured Credit

Nathan Wong
Nathan Wong explains the potential appeal of structured credit in a rising rate environment.
Macro Trends

Geopolitical Upheaval and Unsettled Markets

Jay Kloepfer
Jay Kloepfer analyzes the U.S. and global economies at the start of the year amid geopolitical upheaval and market volatility.

Callan Family Office

You are now leaving Callan LLC’s website and going to Callan Family Office’s website. Callan Family Office is not affiliated with Callan LLC.  Callan LLC has licensed the Callan® trademark to Callan Family Office for use in providing investment advisory services to ultra-high net worth clients, family foundations, and endowments. Callan Family Office and Callan LLC are independent, unaffiliated investment advisory firms separately registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940.

Callan LLC is not responsible for the services and content on Callan Family Office’s website. Inclusion of this link does not constitute or imply an endorsement, sponsorship, or recommendation by Callan LLC of their website, or its contents, and Callan LLC is not responsible or liable for your use of it. When visiting their website, you are subject to Callan Family Office’s terms of use and privacy policies.