US Stocks at Record Highs; Don’t Forget Why Fed is Expected to Cut Rates

Prospects for monetary easing by the U.S. Federal Reserve underpinned global equity markets last week, driving the Dow Jones Industrial Average to a record high, while closing above 27,000 for the first time. The catalyst for the rally was Fed Chairman Jerome Powell’s dovish testimony to Congressional sub-committees on July 10 and July 11. The Fed chief conveyed that the case for more accommodative policy had strengthened since the last central bank meeting on June 18-19, further solidifying expectations for a rate cut at the end of the month.

Last week, the benchmark S&P 500 Index settled at 3013.77, up 0.8%. For the year, it’s up 20.2%. The blue chip Dow Jones Industrial Average finished at 27332.03, up 1.5%. It’s up 17.2% in 2019. The tech-based NASDAQ Composite closed at 8244.14, up 1.0%. It’s gained 24.2% this year.

Help for equity investors also came from the European Central Bank (ECB). A few policymakers strongly suggested last week that the central bank is seriously considering injecting fresh stimulus into the economy through interest rate cuts, or the relaunch of quantitative easing.

Why Did Powell Shift Gears?

Ahead of Powell’s testimony, the biggest thing investors were hoping for from the Fed chief was clarity. No one wanted to hear ambiguity. His choices were cut or no cut. No one wanted to hear, “We’re still looking at the data.”

The hawks were standing their ground ahead of Powell, saying a rate cut at the end of July was unnecessary because of the strength of the labor market, and moderately weak inflation. They looked at the U.S. economy as “not too hot” or “not too cold”. Powell, however, was pretty firm when saying there are concerns about inflation, a global economic slowdown and rising trade tensions. He also added low business investment to the mix of reasons why the Fed should take out “insurance” to sustain the current economic expansion and the continuation of the bull market.

What’s Good about the Economy May also be What’s Bad about the economy

If you asked someone about 10 years ago, “Would you take an economy driven by solid consumer spending, unemployment at 50-year lows, modestly growing wages, and low interest rates? They probably would’ve taken it with both hands. However, this doesn’t seem to be enough for Powell and his FOMC policymakers.

Powell sees risk to too low inflation because it’s too close to deflation. This occurs when demand for goods and services weakens, causing consumer and producer prices to fall. Powell is probably worried that deflation will cause a recession.

The Fed has the weapons to fight inflation, but is very limited in what it can do to fight deflation. Take a look at the Bank of Japan and its battle with extremely low inflation. Powell probably figures it’s better to cut now while the U.S. enjoys the highest global interest rates.

There is nothing the Fed can do to force a quick trade deal between the United States and China. All it can do is soften the blow from dampening business conditions and a disruption in the interconnected world supply chains.

The Fed also can’t stop slowing global economic growth caused by geopolitical uncertainty cause by Brexit, excessive Italian debt and a slowing economy in China. But along with low rates in Japan, Europe, China, the UK, Australia and New Zealand, we can only hope it leads to a more stable global growth picture, higher corporate investment and solid consumer spending.

Volatility Will Be Coming Back

While stock market record highs grab the headlines because of the widely expected Fed rate cut, don’t lose sight of why rates are coming down. Be careful what you wish for. The higher the markets go, the greater the chance for heightened volatility because domestic and global growth could still weaken, trade disputes could remain unresolved and geopolitical tensions could linger or escalate.

Ten years ago, the Fed started cutting rates because of the extreme economic turmoil. The stock market started to rally from a severe sell-off as the Fed held rates at zero percent. Now the Fed is nearly repeating the process as the U.S. equity markets hit record highs. They can’t make the right moves all the time.

This article was originally posted on FX Empire

More From FXEMPIRE:

• Silver Price Forecast – Silver markets rally to open up the week

• GBP/USD Price Forecast – British pound trying to find support

• EUR/USD Price Forecast – Euro continues to run into resistance

• The Battle Is On: Gold Price vs. the HUI Miners

• Natural Gas Price Prediction – Prices Slides as Hurricane Barry Moves Inland

• AUD/USD Price Forecast – Australian dollar continues to stretch higher