Any parent knows that one of the worst things to do when a screaming child is throwing a temper tantrum is to give in and let the kid have exactly what they want – especially in public.
But some market experts fear that’s exactly what the Federal Reserve is about to do, because both stock and bond investors have been having a fit in recent weeks, demanding interest rate cuts.
Why? Because we’ve been here before.
Michael Arone, chief investment strategist with State Street Global Advisors, just wrote a report about this situation with the headline “Spoiled Rotten!” The report included headers such as “I, Me, Mine,” “All I Ever Wanted” and “More, More, MORE!”
“Every time there is a threat of the cycle coming to an end, central bank policy makers step in and soothe things. It’s been like this for a while,” Arone said in an interview with CNN Business.
Friday’s disappointing jobs numbers raised more worries about a looming economic slowdown. But the market rallied because it also cemented expectations of a rate cut – possibly as soon as next month.
Too soon for the Fed to hit the panic button?
Yet some think it’s premature for the Fed to cave to the whims of the market (not to mention President Trump) by lowering rates immediately.
Consumer spending has held up relatively well. The stock market is not far from record highs. And the unemployment rate is still at its lowest level in half a century. With that in mind, it might behoove the Fed to remain patient instead of rushing to cut rates.
That’s especially true since some point out that any recent weakness in the economy and stock market might have more to do with a somewhat manufactured crisis, namely the U.S. trade tension with China.
“Will the Fed follow through and give investors what they want? It’s a little early to throw in the towel and expect them to ease,” said Tony Bedikian, managing director and head of global markets for Citizens Bank. “Barring major escalations in the trade dispute, the economy seems okay.”
Deepak Puri, chief investment officer of the Americas for Deutsche Bank Wealth Management, agrees the Fed should not be rushing to slash interest rates. After all, short-term rates are already low to begin with – at a range of 2.25% to 2.5%.
Fed running out of ammunition if there’s a real economic crisis
That could turn out to be a negative surprise for the market.
“I would not be surprised if the Fed wants to see more evidence of a slowdown before they cut,” Puri said. “The Fed may stay on hold for the next 12 months and investors may get disappointed by the Fed’s inability to cut rates immediately.”
Still, Arone worries that the Fed will cave to Wall Street’s demands once again, and the cycle of low rates boosting stocks will continue. But that could potentially set up the market for an even bigger downturn at some point.
With rates already low, the Fed doesn’t have the ammunition to step in and lift the economy if there is a true crisis.
The Fed’s easy money policies have already been one factor that’s helped marginal “zombie” companies take on more debt without suffering any consequences, Arone noted
He added that more than 30% of the companies in the Russell 2000, an index of smaller companies that have particularly big exposure to the US economy, are unprofitable.
Hold your nose and buy?
“Investors have purchased stocks while having this unsettling feeling,” Arone said. “They are holding their nose and recognizing it’s a challenge. Something is amiss here. This may be the least loved bull market, but investors have no other choices.”
Ed Campbell, managing director and portfolio manager at QMA, is nervous about this as well.
“It’s still a bad news is good news phase for the stock market, but that logic could flip quickly,” Campbell said. “It’s not surprising that hopes of a rate cut are used as a reason to buy. But that can only take the market so far. It should be a rough, volatile summer.”
Arone is even more blunt. He thinks it’s time for the Fed to put its foot down.
“The longer this coddling goes on, the more worried I get,” Arone said. “This is like the turkey that’s getting fed all the way up until Thanksgiving morning. It thinks it’s great until its head is chopped off.”