There are two main constituencies in the U.S. that are hoping for a recession. The financial markets, both stocks, and bonds seem to have a vested financial interest in there being one.
For the bond market, which has been the biggest rooter for a recession, a weak economy means lower loan demand and lower interest rates, which means higher bond prices. For the stock market, a weaker economy, although not necessarily a full-blown recession, promises more accommodation from the Federal Reserve and, therefore, lower interest rates, which generally translates into higher corporate earnings and, therefore, higher stock prices.
The Democrat Party and its allies in the press naturally want a recession simply because it makes it less likely that President Trump will be re-elected. So they are rooting strongly for a recession, although they can’t actually come out and say so.
The recession lobby got some fresh ammunition last week when the Institute for Supply Management’s purchasing managers’ indexes for September came out. They were some of the worst in years, which ignited a rally in the bond market.
On Tuesday, the ISM manufacturing (NYSEARCA:XLI) index slipped further into contraction territory, dropping more than a point from 49.1 in August to 47.8, its lowest level since June 2009, during the Great Recession (there’s that word again).
Unfortunately for the pro-recession crowd, a lot of the rest of the economic numbers aren’t telling the same story. The ISM’s index for the services sector – which covers about three-quarters of economic activity – also came in lower than expected, dropping nearly four points from 56.4 to 52.6, its slowest pace in three years. But it remained well in expansion mode (i.e., over 50). That part of the story got little attention.
Then on Friday came September’s jobs report, which showed employers adding another 136,000 people to their payrolls. While the September nonfarm payrolls number was about 10,000 less than forecast, August’s figure was revised higher by 38,000 to 168,000.
But the biggest headline number was the drop in the unemployment rate to 3.5%, the lowest level since December 1969.
At the same time, the most recent economic growth forecasts by the Federal Reserve and others are coming in at around 2% or slightly north of that for 2019. The Fed is forecasting 2.2% growth for full-year 2019. Last week Charles Evans, the president of the Chicago Fed, said he sees the economy growing by around 2.25% this year. Those aren’t exactly numbers that scream an imminent recession.
Even the Washington Post, not known to be particularly friendly to Trump, noted that “by just about every measure, the U.S. economy is slowing down, but it isn’t collapsing. Among economists, this picture is described as good but not great.”
So, where does this leave the Fed?
The Fed has two more monetary policy meetings this year, one at the end of this month and another one December 10-11, after which it will release updated economic forecasts. Before the IMS manufacturing report came out, another interest rate cut – following those in July and September – was looking a little less than 50-50. After all, at the September meeting, two Fed members, Esther George from the Kansas City Fed and Eric S. Rosengren from Boston – voted against cutting rates, while James Bullard of St. Louis, the long-time dove, wanted a 50 basis-point cut.
After IMS, the odds of at least one more rate cut grew sharply, but after the jobs report, who knows? Depending on what happens in the meantime, I guess is that the Fed will once more come down on the side of caution and lower rates again at either of those two meetings, most likely this month. I’d say the odds of no rate cut at all are in the single-digit percentages. Two cuts seem like overreaching.
Of course, how many times the Fed might cut rates is a different question than whether the Fed should be cutting at all when the economy is growing at 2% or more, we’re at full employment, and inflation is moderate. If that’s not fulfilling your mandate, I don’t know what is.
At least two regional Fed bank presidents have sounded warning bells about the risks to being overly accommodative when the economy is in such reasonably good shape. Last week Cleveland Fed President Loretta Mester, who isn’t a voting member of the Fed’s monetary policy committee this year, joined Rosengren in voicing some concern about the risks involved in keeping policy so loose in the current environment.
“You have to recognize that if you’re running very low-interest rates, that you may be creating some financial imbalances that may come back to haunt you in the future,” she said at a Brookings Institution conference.
“Additional monetary stimulus is not needed for an economy where labor markets are already tight, and risks further inflating the prices of risky assets and encouraging households and firms to take on too much leverage,” Rosengren said, following the Fed’s September meeting.
At what point will the Fed take the threat of inflated asset prices as seriously as it does slightly weaker economic numbers?
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