On Wednesday, the Federal Reserve nudged up short-term interest rates to 2.25 to 2.5 percent, the ninth increase since December 2015. In recognition of slowing growth in China, Japan and Europe and of our own stock market turbulence, Fed officials indicated they would likely raise rates only two times in 2019 rather than the three times they had previously indicated. In addition, the central bankers said they expect to reduce their balance sheet by $600 billion over the next year.
The Federal Reserve now expects core inflation, which excludes volatile energy and food categories, to end up 1.9 percent this year and average only 2 percent over the next three years.
We have now entered a period of normalization. Federal Reserve Chairman Jerome Powell feels that it is time for tough medicine as the “Goldilocks era” of low inflation, stable growth, persistent job gains and easy market gains ends. Instead, the Fed needs to strike a balance between extending the expansion and controlling inflation.
The Federal Reserve disregarded President Trump’s demands that it do everything it can to stimulate growth. For months, Trump has criticized the Fed, saying at one point, “Don’t let the market become any more illiquid than it already is. Feel the market, don’t just go by meaningless numbers.”
Subsequent to the Fed raising rates, Trump tweeted: “I think the increasing of interest rates and the shrinking of the Fed portfolio is an absolutely terrible thing to do at this time, especially in light of my major trade negotiations which are ongoing.”
Powell strongly defended the Fed’s decision to increase rates.
“We think this move was appropriate for what is a very healthy economy. Policy at this point does not need to be accommodative.”
Hedge fund titan David Tepper, in an email to CNBC, said: “Powell told you that the Fed put is dead.” The Fed put refers to the notion that the central bank would take action to support stock prices in times of volatility.
The U.S. economy last year grew 3 percent, an impressive showing. Economists expect output to slow to 2.5 percent in 2019, but both numbers are exceptional. A mature economy such as ours should grow closer to 1.5 percent.
According to the National Bureau of Economic Research, our current economic expansion, which started in June 2009, is the longest on record.
Because of the benefits of the president’s income tax cuts, corporate earnings have grown some 25 percent in 2018. They should slow to 8 percent in 2019.
According to the U.S. Bureau of Labor Statistics, the country’s unemployment rate of 3.7 percent is a 49-year low. Even groups that historically have suffered higher unemployment, such as African-Americans and high school dropouts, have done well. The unemployment rate for black Americans, 5.9 percent, and high school dropouts, 5.1 percent — both are all-time lows.
In contrast to our healthy economy, the S&P 500 Index is at a yearly low, down some 9.6 percent year to date; the Nasdaq Composite Index is down 8.3 percent.
The worst performing sectors are energy, down 21.3 percent; materials, off 20.4 percent; financials, 20.1 percent lower; and industrials, down 17.3 percent.
Despite the strongly growing economy, I would have preferred that the Federal Reserve waited until January before increasing rates. There is no sign of an inflation breakout.
Wages have risen at an annual rate of 3.1 percent. This is understandable, given our healthy labor market, which is adding about 170,000 jobs a month. That said, there is no sign that wage inflation is driving up costs.
And at the same time, the tremors in the stock market, commodities, interest rate futures and corporate bonds imply economic weakening.
The slowdowns in China and Europe should be noted. Sadly, the uncertainty introduced by the president’s tariff battles have reduced trade flows and dampened investment. Hopefully, China and the U.S. can resolve their differences over the next 90 days. A trade fight with China has the potential to materially impact U.S. economic growth.
The larger argument for a pause in interest-rate increases is that the Fed is unwinding the largest monetary experiment in modern history. What is the “normal” interest rate in this post-crisis world? I don’t know, and I doubt the Fed does, either.
Originally published in the Sarasota Herald-Tribune
