November Insights: Was that Necessary?

Was that Necessary?

A common retort to anyone raising teenagers or working with a difficult coworker might be, “Was that necessary?”

If I were Federal Reserve Chair Jerome Powell, I would be asking myself that very same question. The Fed met September 17-18 with the stock market up significantly year-to-date, the economy growing at 3 percent in the second quarter, and unemployment still low by historical standards, and they decided to lower interest rates by 0.50 percent. 

On September 16, the day before the Fed meeting, the yield on the 10-year Treasury was 3.63 percent; by the end of that meeting on September 18, the 10-year rate was up to 3.70. The next day, after the meeting adjourned and the 0.50 percent cut was announced, the 10-year rate actually rose slightly to 3.73 percent. The rise has not stopped, and at this writing the current rate is 4.31 percent.

How can that happen? Didn’t the Fed just cut interest rates? The financial media make it sound as if the Fed is some all-powerful controller of financial conditions – as if when they lower interest rates, suddenly all borrowing cost is lowered, the economy soars, stocks climb, and there is peace on earth and good will towards mankind. If only any of that was true. 

In reality, the Fed controls one rate, and that is the overnight Fed Funds rate. All other interest rates are determined by the market, which is under no obligation to follow the Fed’s action. It has chosen not to do so this time because economic data has been strong. The initial reading for 3rd quarter GDP is 2.8 percent growth. There is no doubt the economy is growing. In a growing economy, investors are going to demand a higher return on their money.

That positive economic data also confirms that the Fed didn’t need to lower rates in the first place. They seemingly talked themselves into it, largely because they believed the pundits who have been crying recession for almost two years now. Either that, or they have done something that no other Fed committee has ever done to my knowledge: lower rates simply to get back to “normal.” If so, then bravo. The Fed has a long history of reacting to a crisis by taking emergency measures and then never accepting that the crisis is over, until their “emergency measures” have caused the next crisis. If they simply moved to get back to normal before causing a new crisis this would be a huge step, but I have my doubts.

I think they lowered rates believing that a slowdown was on the horizon. It wasn’t, and now the 10-year rate, which is most important to investors and homebuyers, is actually up and the stock market has leveled off. The Fed will meet again next week, and they have put themselves in a tough situation. If they hold tight, they basically admit that their earlier cut was too early or too big. If they lower again, they risk reigniting inflation. I’m sure they are looking back at the last meeting and asking the same thing we keep asking our kids, “Was that necessary?”

This is just one more reminder why prudent investing is done from the bottom-up, analyzing each individual investment on its merits, and not from the top down, trying to guess what the Fed will do. Our way may seem simple and perhaps even boring. Making investments based on Fed actions seems exciting, but it has to be stressful. Fortunately, it isn’t necessary.