FED toes a dangerous line!

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FED interest rate hike decision

There is an apparent disconnect in the US economy.  Lately, US stocks were highly bullish, in the backdrop of strong corporate earnings, but market sentiments flailed, as evidenced by a slack in the Michigan Consumer Sentiment, which corrected back to 93.1 from 95.1 a month earlier.  Confidence in future economic prospects has been on a decline, as the expectation index was 10.1 points lower than its January 2017peak.  Contrastingly, the index has shown an improvement in the assessment of current economic conditions, which is the highest level since July 2005.  This can be a recipe for disaster because soaring stocks in the backdrop of a plateauing sentiment could be a precedent for an ultimate collapse in the equities market.  The probability is heightened when there is a lack of policy direction from the Trump administration on how to push the much talked about fiscal agenda, which would allow the economic growth to transcend the 2% mark, prevalent since the end of the recession in 2009.  Economist Richard Curtin, chief economist for the University of Michigan, has stated, that the data is not indicative of an “impending recession,” rather the “hope for a prolonged 3% GDP growth rate” in the imminent future have evaporated.

The US dollar rose sharply post Trump win, as there was clarity of purpose, which was a focus on tax-cut and increased fiscal spending perpetuating growth.  Now a lack of policy enactment has led to a sense of capitulation, and the greenback has been losing ground.  This channelization of policy is important as the ever so important indicator of inflation remains below par, as it fell from 1.9% in May to 1.6% in June.  The FED, on the other hand, has been sending out clear signals for interest rate normalization, up to a point that the stock market can withstand it.  Their primary mindset has been that a strong stock market will contribute to a virtuous cycle, allowing for a trickle-down effect, that will facilitate consumer spending.  This would happen in the backdrop of increased corporate profits which should then have an ameliorating effect on disposable incomes.  Janet Yellen has argued whether a fund rate below 3% impairs the FED to fight the recession, and with this ball park number in mind, mathematically she would have to raise the rates continuously.

Using the term structure and sentiment as a leading indicator of the stock market, the US economy may be heading into an economic slowdown.  This notion is compounded by a lack of policy direction emanating out of the White House, and the concept of Janet Yellen, of increasing interest rates as long as the stock market can withstand it, can have dangerous ramifications.  Other arguments calling for a high-interest rate environment is the fact that it allows for individuals and institutions to reap the benefit of savings, allowing their return on investment to increase.  While currently, there is a fervor for interest rate hike, but Intermarket and terms structure analysis points to a slowdown; hard to perceive for now but surely on the horizon.

Possibly the FED may use federal fund rate or printing money as a tool for offsetting the effects of a slowdown, but then again that would give incoherent signals to the market, perpetuating a meltdown.

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