Research

Economic Insights:
Where to now?

The Fed cut rates for the second time this year and global trade policy is anything but certain. Buckle up because this road will continue to be bumpy.

September 24, 2019

We worry that slashing rates will not accomplish much because lower rates do not remedy trade policy uncertainty or slowing global growth. 

Where to now?

The economic picture certainly didn’t clear up during our two-week hiatus from publishing. The data remains decidedly undecided, though warning signs continue to emerge: profit expectations are weakening, trade and tariff uncertainty abounds and the global economy continues to downshift. Increasingly people are noticing. The business sector turned much less optimistic in recent periods. Confidence among CEOs remains at a moderately pessimistic level. CFO confidence ebbed to its lowest level in three years in the third quarter. Meanwhile, consumers remain upbeat, but not quite as bubbly as earlier this year. While consumer confidence remains elevated, consumer sentiment sits near 3-year lows. The national savings rate continues to hit post-recession highs, driven at least partially by growing concerns about the economic outlook and the desire to save funds for any future trouble. 

Monetary policy responds

Monetary policy is changing in response to this uncertain situation. Last week the Fed cut rates for the second time this year. Interest rates now sit 50 basis points (bps) below their cyclical highs. The Fed is hoping to get ahead of deterioration in the economy. But not everyone on the voting committee agrees that rate cuts should occur or that they will help much. Some think they could cause other problems. Frequent readers of this weekly know that we fall into the latter camp. We certainly understand the action that the Fed is taking, using its most potent weapon. But we worry that slashing rates will not accomplish much because lower rates do not remedy trade policy uncertainty or slowing global growth. Moreover, one of the main arguments behind cutting rates appears questionable. The Fed noted tepid inflation as a risk when defending rate cuts, but core inflation has already stabilized and appears to be headed upward. This reaffirms our belief in only transitory downward pressure on inflation. At a minimum, core inflation is no longer headed downward, though some Fed officials might see this as a sign their policy is already working.

While the rhetoric indicates that talks between the U.S. and China should start again in October, we still see the chances of a grand détente as low. 

The Fed also responded to a disruption in the money markets. The secured overnight financing rate (SOFR) spiked temporarily and the Fed needed to inject liquidity to bring the rate down. This appears temporary, stemming from a brief shortfall in supply when funds flowed from the private sector to the Treasury in order to make corporate tax payments and settle purchases of Treasury securities. The pressure on rates does not appear to have come from any loss of confidence. But this episode could result in the Fed re-enlarging its balance sheet in order to increase reserves and avoid another spell like this. That would not indicate the Fed is beginning another round of quantitative easing (QE) because it would not be designed to systematically lower rates, just address a technical issue.

Trade policy still problematic

We experienced little progress on the trade policy front. Trade policy uncertainty, or TPU as the Fed has used, remains high. In addition to its impact on business sentiment it also impacted hard data: exports have declined, the manufacturing sector weakened, corporate profits have declined, and economic growth among major global exporters has stalled and, in some cases, contracted. While the rhetoric indicates that talks between the U.S. and China should start again in October, we still see the chances of a grand détente as low. We believe that smaller, limited agreements remain the more likely outcome, but even those seem difficult. Further tariffs or increases in existing tariff rates are scheduled for the fourth quarter if no progress occurs.

Geopolitics casts a shadow

Heightened geopolitical risk also continued over the last few weeks. Focus seems to simply shift from issue to issue as new risks emerge to take the spotlight from existing risks. The brazen attack on Saudi Arabia’s oil infrastructure caused a temporary record spike in oil prices, though that proved ephemeral. More important than the direct impact on the oil price per se, it served to highlight the precarious nature of the geopolitical situation around the world. More recently, attention has returned toward the domestic front as the administration’s dealings with Ukraine now primarily occupying the public consciousness. We expect this capricious situation to continue, with attention shifting from one risk to the next. And elevated geopolitical risk occurring at a time of building economic headwinds serves as another potential obstacle the economy could face despite no shortage of obstacles.

What it means for CRE

For commercial real estate (CRE), nothing in the overall landscape changed over the last few weeks. While the spike in SOFR caused some consternation, it appears to be a temporary shortfall in supply of overnight funds primarily centered around tax payments. While that could occur again around payment dates in the future, Fed expansion of reserves should help alleviate any future surge in rates. Declining interest rates could further embolden an already expensive CRE market (and other expensive asset markets) raising the possibility of bubbles forming. We do not believe this to be true yet but remain cautious of the possibility which has also been raised by some key Fed officials. And for now, CRE is weathering TPU well, though the prospect of more tariffs on consumer goods increases the probability that the industrial and retail sectors become collateral damage.

What we are watching this week

Consumer confidence for August should remain at a high level, but potentially decline slightly as the trade war seeps into consumer consciousness. The final reading on second quarter GDP growth should show little to no change. Durable goods orders for July likely contracted, bearing the direct brunt of the trade war and slowing global growth. And core inflation in July, measured by the personal consumption expenditures (PCE) index will continue to firm up on a year-over-year basis, heading back towards the Fed’s target rate of 2%.

Thought of the week

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