Markets Signal Two Rate Cuts This Year – Not Likely

The media would have us believe that Trump’s trade war with China and now Mexico is starting to scare people, especially with the 5% across-the-board tariff on Mexico goods and services going into effect on Monday. This is despite the fact that the Consumer Confidence Index was near the highest in 20 years in May, as I showed you in last week’s Blog.

Despite that, the financial markets seem convinced that Trump’s tariffs are going to derail the economy and lead to a recession. Treasury yields have fallen significantly in the last few weeks, with the 10-year Treasury Note plunging to near 2% this week, suggesting an economic slowdown. The interest rate markets are, in effect, demanding that the Fed cut rates.

It gets even worse: The Fed Funds futures markets are predicting a 90% chance that the Fed will cut rates at its September 18 FOMC meeting and again at its December 11 meeting. Wow! This is despite the fact that the Fed’s current policy is to “watch and wait” (ie – do nothing).

Federal Reserve Chairman Jerome Powell was asked on Tuesday if the central bank is prepared to act to sustain the economic expansion if President Trump’s trade war weakens the economy. He replied:

“We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the US economic outlook and, as always, we will act as appropriate to sustain the expansion…”

Notice Mr. Powell did not say that the Fed would cut interest rates, but the markets reacted as if he did. Stocks, which have been under downward pressure for the last month, exploded higher on Tuesday with the Dow Jones Industrial Average up over 550 points. The S&P 500 Index soared 2.1% on Tuesday, its second-best showing this year. Both indexes were higher again yesterday.

My position has not changed. The Fed does not want to cut interest rates with the economy running at 3%. If anything, the Fed would like to get one or two more rate increases this year, if it could. Yet as we all know, the Fed changed course earlier this year and promised to be “patient” with regard to future rate hikes.

All Mr. Powell was saying, in my opinion, is that the Fed would act to cut rates IF there are clear signs the economy is heading for a recession. Put differently, I believe the financial markets have overreacted. Over 90% chance of a rate cut in September and another one in December… give me a break!

Now, as I discussed in Forecasts & Trends on Tuesday, most forecasters have trimmed their estimates for growth in the second half of this year. The Atlanta Fed and the New York Fed believe the economy has slowed down significantly already with GDP readings of only 1.3% and 1.4%, respectively. If these estimates prove accurate (they do change frequently), that is certainly a significant slowdown from 3.1% in the 1Q. But it is not a recession.

In my view, the only way the Fed cuts rates this year is if the FOMC fears we are headed for a recession. The rate cut crowd may be very disappointed!

FYI, the next Fed Open Market Committee meeting is Tuesday/Wednesday, June 18-19.

Raise Taxes on Americans to Punish Mexico For Immigration

As noted above, President Trump’s first round of tariffs on Mexico go into effect on Monday with a 5% tax on all goods and services, escalating to 25% by October 1st. I know he knows better, but Mr. Trump continues to insist that Mexican exporters will pay the tariffs. No, they won’t! American consumers will pay all or most of the tariffs in the form of higher prices.

Most Americans don’t know this yet but Mexico has quietly become our largest trading partner, surpassing China and Canada which have long held the #1 and #2 spots. In 2018, the US bought $671 billion in Mexican goods and services, whereas Mexico bought only $299 billion in US goods and services. Importantly, about half of the Mexican imports to the US are actually parts and inputs that go into final products produced in America.

Mexico was able to jump into the #1 spot primarily because we imported less last year from China (down 13.5%) and Canada (down 4.1%). Trade with Mexico increased by 3.4% last year.

While all US states will be negatively affected by the trade war, Texas will be harmed the most. Texas is the nation’s top exporter, and it sold over $97 billion in goods and services to Mexico last year. That includes computers and electronics, transportation equipment, energy, agriculture, etc. It is estimated that apprx. 37% of Texas’s exports are sent to Mexico. Texas has an $8.5 billion annual trade surplus with Mexico. Sales into Mexico constitute about 5.7% of the Texas Gross State Product.

I mention this only because President Trump has threatened to close the border between the US and Mexico more than once. While closing the border seems to be “off” the table, in lieu of escalating tariffs, it would be an absolute disaster for Texas if the president closes the border! For this reason, and because Trump must win Texas to get re-elected, I don’t think he’ll do it.

One Response to Markets Signal Two Rate Cuts This Year – Not Likely

  1. Congress is too damm dumb to wipe their butt after they pooped in their pants.They can’t/won’t do anything

    Trump & tarrifs: If not NOW, When? China, Mexico, EU etc etc have been taking advantage of US for years. Give Trump a Chance!