The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

World’s Fed

08/01/2019

Yesterday, the Federal Reserve System of the United States of America did two things.  First, they decreased interest rates by a quarter point (25 bps).  The stock market however wanted a half point (50 bps), and the Dow promptly dropped 333 points.  The market also wanted the Fed to promise that this was only the first decrease in a series but were disappointed by that as well.  Just another meaningless tantrum by the stock market!  Second, the Fed said they would end their policy of quantitative tightening, in which they withdrew $50 billion of “liquidity” each month.  That means the balance sheet of the Fed remains too high and limits their “dry powder” for the inevitable next downturn.

Six months ago, the economic data started weakening, and forecasts of corporate earnings also weakened.  This increased the probability of another economic slowdown, maybe even a recession, in the near future.  That might have been an appropriate time to stimulate the economy by decreasing interest rates.  Since then, economic data has stabilized, and corporate earnings have been stronger than expected (76% of Q2 earnings beat expectations).

Wait a minute — decreasing interest rates makes sense when facing economic weakness but not now!

I believe this is the first time that the Fed has stimulated the U.S. economy, because the world economy has weakened.  We are indeed the world’s #1 economic engine and might need some additional horsepower.  The Fed also talked about the uncertainty caused by the trade war and cut interest rates as insurance.  It was a preemptive rate cut, for the benefit of the world.

By the way, the Fed vote was not unanimous, which is unusual.  Two members dissented against the rate cut.  I would have voted with the dissenters.

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