Eyes on the Fed - June 17, 2019

The Federal Reserve’s two-day meeting concludes on Wednesday. A recent shift in the Fed’s stance, hinting it is open to rate cuts to support the economy, has aided investor sentiment.

That said, most observers don’t believe Wednesday’s meeting will end with a cut in the fed funds rate, which is at 2.25-2.50%. Recent data are not signaling an emergency cut in rates is needed.

On Friday, the government reported retail sales rose a respectable 0.5% in May, and April’s numbers were revised significantly higher.

In turn, the Atlanta Fed’s Q2 GDPNow model boosted its estimate of growth from 1.5% to 2.1% (as of June 14 per the Atlanta Federal Reserve).

So, let’s take a stab at how the Fed may frame the situation going forward. For starters, we may see a shift in the Fed’s language. Fed Chief Jerome Powell’s June 4 comment, “We will act as appropriate to sustain the expansion,” might be inserted into the statement. It’s the Fed’s way of saying it is willing to cut interest rates if needed.

But, will the Fed wait for the economy to show significant cracks before it acts? Or might it opt for an “insurance” cut(s)? During 1995 and 1998, the Fed lowered rates as a precaution.

Today, the trade situation’s overall impact on economic activity is uncertain. It weighs on business confidence. But how that may hamper business spending is difficult to model, as there aren’t any modern historical precedents to follow. Precautionary moves might be in order.

A closely followed gauge put out by the CME Group currently places odds of a July rate cut at almost 90% (as of June 14; note: probabilities can change without notice).

Possible market reaction to an easing by the Fed

The graphic below illustrates how the S&P 500 Index performed after the Fed implemented its first rate cut during the last nine rate-cut cycles dating back to 1974 – from 1 month to 12 months after the first reduction in the fed funds rate.

The median return one-year later: 20.8% when the economy did not enter a recession (4 instances). When a recession ensued (5 instances), rate cuts did little to prop up shares.

Historically, the data tells us that investors found little temporary solace in falling rates when a profit-killing recession ensued. But lower interest rates, coupled with economic growth, have historically aided stocks.