WASHINGTON: Last Wednesday, the Dow Jones Industrial Average fell 800 points. That’s fourth-largest one day point drop ever. The drop was fueled by the fear of a recession. That perception is likely wrong. Even if the economy is slowing, it’s the Federal Reserve’s Monetary Policy that is the primary cause.
Fortunately, the Federal Reserve is changing direction.
The trigger for the large drop in the stock market was the inverted yield curve. This happened just prior to the last seven recessions. Because every time the yield curve inverts, a recession does always follow.
What is an inverted yield curve?
Because interest rates and yields reflect risk, long term rates should always be higher than short term rates, simply because the longer the bondholder’s money is invested, the more risk that is incurred. That’s a normal yield curve. When long term rates are lower than short term rates, the yield curve has inverted.
Last Wednesday that happened. Investors who are more uncertain today than in the past quickly reacted to this news by selling off stocks. They believed that a recession is coming in the near future. If they are correct, corporate profits will fall and stock prices will follow. So investors looked to sell now before stock prices fall significantly.
Is a recession coming anytime soon?
The short answer is no. Even if the yield curve is signaling a recession, history indicates that a recession followed about two years after the yield curve inversion. A recession is likely even further away than two years. In fact, had the FED not been so aggressive with their interest rate policy, the economy might be growing at a 4% rate today.
From the time of President Trump’s election in 2016 until the end of 2018, the FED raised interest rates 8 times. While short term interest rates were near zero at the time, the rapid increase in rates tended to slow economic growth.
Trump’s primary economic policy goal is economic growth, which is exactly what it should be. Prior to Trump, the economy hadn’t seen a 3% annual growth rate since 2005. We haven’t had 4% annual growth since 2000. That’s the longest period of economic stagnation ever.
President Trump removed growth stifling and counter-productive regulations.
He also convinced Congress to reduce tax rates for all Americans and for corporations. Additionally, he convinced Congress to repeal the portions of the Dodd-Frank bill that limited banks ability to make loans. These actions increased economic growth.
Trump’s actions would have led to growth rates approaching 4% annually, had the FED not been so aggressive. At the end of 2018, the FED signaled more rate hikes were coming. Fortunately, they have reversed that policy. Last month they reduced short term rates by ¼%. They should have reduced rates by ½%. Had they done that, the inverted yield curve would not have happened.
In other words, the yield curve is inverted not because long term rates are low, but rather because short term rates are too high.
Don’t blame the messenger – Trump is correct
While we can debate whether Trump’s style is effective (he called Federal Reserve chairman Powell “clueless”), Trump’s message is correct. The Federal Reserve increasing of interest rates too quickly, should reverse their actions especially considering there is no sign of an over-heated, inflationary economy.
Even though annual wages increases exceed 3%, this is not inflationary. That’s because worker productivity is exceeded by 3.5%. As long as productivity increases exceed wage increases, labor costs will fall not rise.
Additionally, Trump’s tax cut was supply-side oriented meaning any increase in market demand can be met with an increase in supply, so there is no upward pressure on prices.
President Trump’s economic policy has resulted in increased economic growth, low inflation, historically low unemployment, and more opportunity, especially for lower-income workers. If the Federal Reserve would be more accommodating, growth can increase more and bring more positive results.
The Fed should move to reduce rates and they should do it quickly. A ½% rate cut in September is just what the economy needs. Let’s hope the FED sees it that way.