THE MIGHTY U.S FED - Just a few word may change everything
Friends, U.S. Markets have come back strong these first couple weeks of June after a rough May (+4.6%, -5.7%, S&P500, Respectively). Year-to-date, the U.S. stock market has risen 15.1% (S&P 500), sitting slightly below its peak in April 2019.
U.S. trade renegotiations with China and Mexico have been blamed as the cause of investor’s anxiety. Although there seem to be positive results in the U.S. vs. Mexico negotiations this week, we must face the fact that the U.S. could maintain a position of trade tension with the rest of the world, whether or not a previous deal is in place.
Since the crisis of 2008, investors have been addicted to the Federal Reserve to lowering interest rates to solve economic problems.
Last week, the Federal Reserve held its Conference on Monetary Strategy, Tools, and Communications Practices. In his opening speech, Federal Reserve Chairman Jerome Powell commented: "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 an active labor market and inflation near our symmetric 2 percent objective ".
As hoped, investors interpreted those words as evidence the Federal Reserve will be lowering interest rates sooner than later. Perhaps overly optimistic, the market now expects multiple interest rate cuts in 2019 with a high level of certainty (90%).
The markets believe that reductions in interest rates will solve their worries and maintain economic growth. With a decrease in rates, debt payments will be reduced, asset prices will rise, and general consumption will be supported. However, this alone will not compensate for the loss of international sales due to the increased tariffs.
The U.S. Congress gave the Federal Reserve two mandates: to ensure labor stability and control inflation. Typically, the Federal Reserve will wait until it is sure that economic conditions have deteriorated before using their tools.
So potential actions by the Federal Reserve to stimulate the economy is bittersweet. It would provide evidence that the economy is not in the best condition and therefore needs work, but stimulates future economic growth. If the Federal Reserve does not take action in 2019 to cut rates, investors will be disappointed, and the market will react accordingly.
Currently, the U.S. economy continues to grow, only at what is beginning to look like at a lower rate than in the previous two years. Two critical indicators were reported that may prove this weakness: a decrease in the expected rate of growth of industrial activity in the US, and a May jobs report showing growth much lower than expected.
However, the level of unemployment is at its historical minimum, and the inflation is still in the normal range — both critical elements of the Federal Reserve's control panel. As such, we believe the most likely scenario is that the Federal Reserve does not act in the short term. If they act so soon, they will risk being without enough tools to make further necessary changes in the future.
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Have a productive week!
- Michele López