Jerome H. Powell

Fed Chairman Blinks: Fewer Rate Hikes Possible

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

December 4, 2018

IN THIS ISSUE:

  1. Fed Chairman Suggests Rate Hikes Could End Soon
  2. Recession Fears Continue to Grow – The Question is, Why?
  3. Presidents Trump, Xi Agree to Temporary Truce in Trade War

Q3 hedge fund letters, conference, scoops etc

Jerome H. PowellOverview

In a speech last Wednesday, Fed Chairman Jerome Powell surprised the world with a reversal of his hawkish rhetoric regarding additional interest rate hikes. While another quarter-point rate hike is expected on December 19, most Fed-watchers now expect only one or two rate hikes in 2019. Stocks rallied strongly on the news.

On another subject, more and more forecasters believe we will have a recession beginning late next year or early in 2020. Yet the facts just don’t support these predictions. This is the second longest economic recovery on record and will become the longest if it continues next year. It is for this reason that some analysts assume a recession is coming soon, even if there is no evidence of it at this point.

Finally, President Trump and China’s President Xi didn’t reach an agreement to end the trade war at the G-20 Summit last weekend, as I predicted. But they did agree to a 90-day truce on additional tariffs and further negotiations on ending the trade war. We’ll see how that goes. The truce was enough to boost equity markets around the world.

Fed Chairman Suggests Rate Hikes Could End Soon

The most important development over the last week came on Wednesday in a speech delivered by Federal Reserve Chairman Jerome Powell. With just two words, the Fed’s leader sent stocks surging by raising hopes that the central bank might be close to ending its push to drive up interest rates.

The two words: Mr. Powell said the Fed’s benchmark interest rate was “just below” the so-called neutral level, meaning the central bank was close to the point where it would not be raising the Fed Funds rate every few months.

Only last month, Mr. Powell said the Fed Funds rate, at 2.0-2.25%, was “a long way” from neutral, leaving investors worried that the rate increases would continue with another quarter-point rise on December 19, followed by 3-4 more hikes in 2019. Yet Powell seemed to back off.

Powell’s words sent stocks soaring 2.3% on the day, erasing the losses from a rocky November. To investors, the new “just below” wording meant that the central bank might leave Fed Funds rate closer to its current level, keeping in place the stimulus that low rates have provided to a 10-year-long bull market in stocks.

Some analysts warned that investors were overreacting since there was no other reference to a change in policy plans in Mr. Powell’s speech. Others suggested that Powell’s comment that the Fed Funds rate is nearing neutral, at which time the rate hikes could presumably stop, was a concession to President Trump who has frequently criticized the Fed for unnecessarily raising interest rates. I find that doubtful.

Powell repeatedly said the Fed’s decisions on interest rates are “data dependent” and will be made based primarily on the economy and inflation. I think he simply meant that if the economy slows down some next year, as most forecasters expect, there won’t be the need to raise rates 3-4 times – maybe only once or twice.

If we get a rate hike on December 19 to 2.25-2.50% as expected, and then two more hikes in 2019, that will put the Fed Funds rate up to 2.75-3.00%. I think Powell might have been signaling he could live with that. We’ll see.

Recession Fears Continue to Grow The Question is, Why?

I’m reading more and more forecasters and analysts who believe we’ll have a recession in the second half of next year, or if not, then certainly in 2020. As I have written repeatedly over the years, no one can accurately predict recessions. And there are really few indications that we’re headed for one anytime soon.

There’s an old saying on Wall Street that “economists have predicted eight of the last two recessions.” The bears in the economics profession keep getting paid a lot of money misreading the nation’s economic weather vanes. Most of Wall Street’s top economic gurus thought Trump would crash the stock market and the world economy when he took office.

Yet here we are with near 4% GDP growth over the past six months and a prediction for the year of close to 3.5% percent. That’s not a crash. So the question is, why are more and more forecasters predicting a recession late next year or certainly in 2020?

Part of it I think is the fact that this is the second longest economic recovery on record, now almost a decade. If it continues into next year, it will be the longest on record. As a result, more and more analysts are assuming that a recession must be just around the corner. But the facts just don’t back-up that assumption.

Just listen to this illogic from the latest Goldman Sachs report: “Tighter financial conditions and a fading fiscal stimulus” –  from the Trump tax cuts and $300 billion of new federal spending – “will be key drivers of the deceleration” in the economy next year and in 2020.

I disagree. The Trump tax cuts should continue to stimulate the economy every year they are left in place. The fact that the $300 billion in extra spending may go away (there’s no guarantee of that) shouldn’t be bad either. In the 1990s, the economy boomed and the stock market soared even as government spending fell by 3.5% of GDP, the largest percentage drop since the end of World War II.

Three forecasters I respect – Art Laffer (Laffer Curve), Larry Kudlow (current Trump adviser) and Stephen Moore (Heritage Foundation) believe we could get several more years of 3-4% GDP growth beyond this year.

They believe this primarily because the current economic recovery has been so slow, largely due to eight years of President Obama’s anti-growth policies and tax increases. They believe this economy has plenty of juice left in it.

They also believe the current 3-4% expansion can continue without significantly higher inflation which, of course, is the Fed’s greatest concern. They point to the fact that In the 1980s, we had numerous quarters of 8% growth and some years of above 5% growth, and yet we had lower inflation.

I’m not suggesting that could happen again now, but inflation fears should not be driving the Fed at this point. Maybe Fed Chairman Powell has figured this out, and that led him to make the dovish statements he did last week. Just my theory.

Finally, I should point out that for some of the economic naysayers who are predicting a recession next year, it’s just wishful thinking. These “Never-Trumpers” would welcome a recession so that President Trump does not get re-elected. Sad but true.

The bottom line is that fears of a recession next year or in 2020 are overblown in my opinion. Sure, it could happen; negative surprises happen. Yet I could see this strong recovery continuing at least a couple more years.

Presidents Trump, Xi Agree to Temporary Truce in Trade War

In my Blog last Thursday, I predicted that President Trump and China’s President Xi Jinping would not reach a deal to end the trade war at the G-20 Summit in Buenos Aires last weekend. They didn’t. Instead they agreed to a 90-day truce on the implementation of new tariffs.

The truce between the US and China emerged after a highly anticipated dinner last Saturday between Trump and Xi on the sidelines of the G-20 summit in Argentina. The leaders agreed to pause the introduction of new tariffs and intensify their trade talks just ahead.

The White House called the meeting “highly successful,” saying the US will leave existing tariffs on $200 billion of Chinese goods at 10% percent and refrain from raising that rate to 25% as planned on January 1. In exchange, the US wants an immediate start to new talks on Trump’s biggest complaints about Chinese trade practices: intellectual property theft, non-tariff barriers and cyber theft.

After 90 days, if there’s no progress on structural reform, the US will raise those tariffs to 25%, White House Press Secretary Sarah Huckabee Sanders said in a statement. China also agreed to boost its purchases of agricultural and industrial goods to reduce its trade imbalance with the US, she said. President Trump said the following in his post-meeting statement:

“This was an amazing and productive meeting with unlimited possibilities for both the United States and China. It is my great honor to be working with President Xi.”

Investors have been eager for signs of progress toward keeping an already costly trade dispute from spiraling into a new and broader cold war. White House economic adviser Larry Kudlow said that the meeting went “very well” in a brief comment to reporters as the Trump delegation left Buenos Aires for Washington.

The outcome gives both sides enough to boast of a win but without resolving the fundamental differences between them. China gets a delay on additional tariffs, while the US gets greater purchases of agricultural and industrial goods and other concessions.

It remains to be seen if China will cease its theft of US intellectual property and other cyber threats. There is also the question of the relatively short 90-day window that was agreed to. Some analysts believe that a more comprehensive trade deal must already be in the works; otherwise, the two leaders would not have agreed to such a tight window.

So, we’ll have to see what happens.

Best regards,

Gary D. Halbert

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