The market is forecasting a 100% chance of the Federal Reserve lowering short term interest rates on Wednesday for the first time since 2008.
While historically a rate cut signifies uncertainty in the economy, the United States economy has been experiencing growth along with a robust job market. The U.S. household is also quite strong. Consumer confidence is high and household debt is low.
The demand from consumers, coupled with lower corporate tax rates have been greatly benefiting U.S. corporations. As of today, the proof is in the pudding as these factors are translating to U.S. corporations continuing to report strong earnings.
So why are we cutting rates? It is not like interest rates are so high, corporations and individuals are avoiding capital investment. Interest rates at the current level remain well below historical averages. Some may point to a decelerating global economy and continued risks of U.S. and China trade negotiations. Or perhaps it is political pressure from the Trump administration.
In my opinion, Europe cutting interest rates last week is the clear sign rates will go down. There is a high correlation between LIBOR (The London Inter-bank Overnight Rate) and the U.S. Fed funds rate movement, with LIBOR acting as a leading indicator of what the Fed will do.
While many continue to point to an outlook of doom and gloom for what may lay ahead because of what an interest rate cut may signify, I prefer to stay grounded in economic reality. Leading economic indicators are still signaling expansion.
A yield curve inversion is high probability of an impending recession or stock market correction. Many are currently speaking about how the short end of the yield curve being inverted currently and how this is a sign of bad things to come. However, the inversion of the 2-year and 10-year treasury is actually the correct major leading indicator of a recession. This measure has not been inverted. If the Fed does lower short-term rates on Wednesday this could possibly correct the inversion on the short-end of the yield curve. Correcting the inversion of the short end of the yield curve is more likely the reason for cutting rates on Wednesday.
Fiscal policy is not resistant or hawkish. In a rare move of compromise the Federal government moved to raise the debt ceiling last week. With the Fed having an extremely high probability of lowering rates and not raising rates in 2020, monetary policy is also not resistant in the short run. Therefore, all signs point to a continued bull market for the third quarter of 2019 and beyond, until the data shows us otherwise.