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The Fed Has Become Irrelevant

July 18, 2019
Until recently, Fed Chair, Jerome Powell sounded a consistent theme: the Fed is data-dependent and will stay that way, unswayed by noise or pressure from politicians. When the FOMC released its rate decision last month, it got as dovish as it could without actually cutting short-term rates. It downgraded its assessment of economic growth from "solid" to "moderate" while noting that "market-based measures of inflation compensation" have declined. 
However, the Fed added that "uncertainties...have increased" and it will "closely monitor" incoming information and "act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent (inflation) objective." It removed the reference in prior statements to be "patient" about changes in policy. This statement, as well as comments made by Powell at the press conference after the meeting, suggested a 25 basis point rate cut was all but in the bag for the next meeting at the end of July. 

But with six weeks between June and July's meetings and a full economic data cycle, what we have seen so far shows that - if the Fed really is data-dependent - they shouldn't cut rates. And if they do, they should lose credibility. Personal income and spending numbers came in strong for May. Income grew 0.5% while spending grew 0.4% (and was revised higher for April). Non-farm payrolls increased 224,000 in June, well above expectations, and initial unemployment claims remain near historically low levels. 

Auto sales also beat consensus, coming in at a 17.3 million annual rate in June. Its true consumer prices were up 1.6% for the twelve months ending in June, while producer prices were up 1.7%, both below the Fed's 2% target. But "core" consumer prices - which strip out the volatile food and energy categories to give a better picture of trend inflation - are up 2.1% from a year ago while "core" producer prices are up 2.3%. There is no sign of aggressive disinflation, and certainly not deflation. 

So now in addition to their dual mandate of "employment and inflation," the Fed has added "uncertainties" about weakness in foreign economies to its list of actionable items. There are still several important data points due out before the Fed's decision on July 31. Next week, look for a report on second-quarter real GDP growth in the 1.5 - 2.0% range, held down temporarily by a slowdown in the pace of inventory accumulation. And then more personal income and spending numbers for June to cap things off. 

Combined, this data will not show any significant slowdown in the U.S. economy. But the Fed seems obsessed with developments abroad, including slower growth in China and Europe. This is neither "data dependent" nor logical. China is a communist country, and communism has never worked at creating wealth in the long run. China grew rapidly for decades by importing foreign technologies, exporting to the West, and lately, stealing intellectual property from abroad. These shortcuts have now run their course. If anyone thinks monetary policy in the U.S. can solve China's problems, they're dreaming. Given the size of China's economy, is US contagion a concern? Hardly. The last time the second-largest economy in the world collapsed (Japan in 1990), the U.S. boomed. How about Europe? Do you really think the Fed can fix slow economic growth caused by the socialist policies across the sea? High taxes, regulations, and spending can't be fixed by the ECB's negative rates, so how the Fed thinks it can help is a mystery. The Fed is not tight, there are still $1.4 trillion in excess reserves in the banking system. Most importantly, "data dependence" seems to be out the window.

I apologize for all the data that I shared with you but that was the only way to prove my point about the irrelevance of the Fed. Going forward we continue to look at data and make our own assessments and not look to the Fed for direction.

Equities: After seeing the lowest volume on the major indexes of the year two weeks ago, due to the shortened trading week, we saw a little pickup last week, but not much as volume on the major indexes remained far below average. The Dow last week posted the largest gains, thanks to the concentration of the index. United Health moved significantly higher on the announcement that the current US administration was no longer going to pursue cutting payments from Medicare and Medicaid to bring down the cost of healthcare in the US. For the week last week, United Health alone accounted for one-third of the total gain for the Dow. Aside from healthcare, technology continued to be a driving force behind the major market movements, while the Small-cap Russell 200 index posted declines for the week.

○ Dow (1.52%) - Below Average volume 
○ NASDAQ (1.01%) - Below Average volume 
○ S&P 500 (0.78%) - Below Average volume 
○ Russell 2000 (-0.36%) - Below Average volume
Source : Monday Morning Outlook 6-17-19: Callahan Capital Management Weekly Commentary 7-15-19
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