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Aug 02, 2019

It's About Expectations

Bill Miller

A Few Comments on the Fed's Actions

The problem with the Fed’s 25 basis point cut yesterday was not in the messaging as expressed in Chairman Powell’s press conference, which is the consensus view, but in the substance of what was done. The Fed seems not to understand that when you do what the market is already expecting, as it did yesterday with the 25 basis point reduction, you do not change expectations, you only reinforce them. Since forward-looking global indicators have all been pointing to a slowing global economy, the cut did nothing to change expectations about growth or inflation. It is worrisome that the result of yesterday’s decision sent stocks down and the dollar up, and that is now being followed today by a sharper decline in stocks, a big rally in treasuries and a big decline in inflation expectations: the exact opposite of what the Fed wants to happen. The move today is being ascribed to the new tariffs being levied on China, but the amount of the move in inflation expectations and bond prices is way beyond the modest slowing effect those tariffs will have on the US economy. With the yield curve now more, not less inverted, the recession warning signals are growing. Not helping any yesterday were the dissents from two Fed governors who thought rates should not have been cut at all. They seem not to understand that almost all economic data reports the past and has very little predictive value unless the data points are consistent with a pre-existing trend. The data points mostly are: the trend is things are slowing and the Fed’s “symmetric” 2% inflation target is receding. There is very little to support a “do nothing” view about yesterday’s rate action except ideology.

If the Fed wants to change expectations about growth and inflation as reflected in capital markets then it will have to do something unexpected, i.e., cut more than the market is expecting. When the Fed gets it right bonds should fall, stocks should rise, inflation expectations as revealed in TIPs spreads should rise, and the dollar should fall. Markets are not, of course, perfect forecasters, but they are a whole lot better than the Fed or the Council of Economic Advisers, neither of whom has EVER predicted a recession. One of two things will happen over the next several months: either the reported economic numbers will accelerate more than the market-implied prices suggest or they won’t. If they do, then bonds will fall, stocks will rise, etc. If they don’t bonds will rise, stocks will fall, etc. until the Fed either gets it right or we have a recession that forces their hand.

General MacArthur once said that every military disaster can be summed up in two words: “too late.” The same can be said of every economic disaster.

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