Insurance and the Federal Reserve, a Tantrum, and China Tariffs - August 5, 2019

The Federal Reserve cut its key lending rate by ¼% to 2.00 – 2.25% on Wednesday. It framed the reduction as insurance against any downside economic risks posed by weak global growth and trade tensions. It was the first reduction in the fed funds rate since the financial crisis.

The immediate result – expect a downtick in savings rates and some borrowing costs. The decision was 8-2, with two dissenters voting to keep rates unchanged.

Trader tantrum

In his press conference, Fed Chief Jerome Powell was quick to point out that this was not expected to be the “beginning of a lengthy cutting cycle.”

Given the modest pace of U.S. economic growth, one wouldn’t expect the Fed to significantly lower interest rates at the current time.

Despite language in the Fed’s statement that it is still eyeing a looser monetary policy, short-term traders sold into his comments, mistakenly inferring his remarks meant “one and done.”

The reaction forced Powell to clarify his earlier comment. “Let me be clear. I said it's not the beginning of a long series of rate cuts. I didn't say it's just one or anything like that,” he said.

Instead, Powell said the Fed will rely on the economic data as it decides how to implement monetary policy… with one caveat: the uncertain impact from trade tensions and trade headlines may still influence what the Fed could do.

Was Wednesday’s decline a market misinterpretation or a Powell miscue? I tend to believe traders were expecting a much more dovish tone. For longer-term investors, daily volatility is unavoidable and has been inconsequential to one’s long-term financial goals.

On second thought

Stocks rallied sharply Thursday morning amid expectations the Fed was still considering at least one more ¼% rate cut.

The rally ended abruptly Thursday afternoon when President Trump tweeted he will impose a 10% tariff September 1 on the remaining $300 billion in Chinese imports. The new levies will be aimed at consumer goods.

Not surprisingly, Chinese officials are considering retaliatory measures, though as the Wall Street Journal opined, its options appear limited. Currently, $250 billion in Chinese goods are subject to a 25% tariff.

The trade war, coupled with slowing global growth, is pressuring manufacturing.

Yet, consumer spending has been strong, and the economy is generating a decent level of new jobs, albeit, at a slower pace than 2018.

Nonetheless, another ratcheting up of trade tensions creates an added degree of uncertainty. We see that playing out in short-term market moves, which forces investors to adjust to the idea that the trade war with China could be with us for a while.

The silver lining: the growing economy has softened the downside for stocks.