Why the US doesn't need a rate cut now

June 20, 2019 10:25
With unemployment at 3.6 percent and annualized GDP growth expected to remain above 2.3 percent, demands for a rate cut in the US are unwarranted, argues a market watcher. Photo: Bloomberg

The United States does not need a rate cut now.

Consumer confidence is high, unemployment is low and Treasury yield is at 2.1 percent, while credit to the economy and corporate financing are also holding up.

The weakness in core consumer prices in May, which increased by only 0.1 percent, was entirely due to lower prices of used vehicles, and core CPI inflation remains within the Fed target, falling from 2.4 percent in mid-2018 to 2.0 percent in May.

Headline CPI inflation fell to 1.8 percent in May due to lower energy prices, so there is absolutely no logic in a rate cut.

With unemployment at 3.6 percent and annualized GDP growth expected to remain above 2.3 percent, demands for a rate cut are only an excuse to keep financial asset prices higher at any cost.

There are some elements that point to a slight weakness in the economy but no need for a rate cut.

- Industrial production rose 0.4 percent month on month in May while it stalled in other global economies.

- A strong 0.5 percent rise in underlying retail sales in May, along with upward revisions to previous months’ gains which means consumption is likely to grow close to 4 percent annualized in the second quarter.

 - The headline confidence index declined marginally to 97.9 in June, from 100.0, but remains at very high levels.

A rate cut would only fuel the debt bubble further, and leave the Fed with fewer tools to address a slowdown. When so-called “High Yield” means 365 bps for junk bonds of companies close to bankruptcy and Treasuries yield 2.1 percent there is no reason at all to cut rates. Rather the opposite.

The debt bubble is dangerously inflated and lower rates would only make it worse. The ratio of US corporate debt to GDP, as well as the high-risk loan figure and securitized debt, have risen to pre-crisis levels.

US deficit is rising because spending soars and the government finds debt cheap and abundant. Government spending rose to US$440 billion in May 2019, up 21 percent from May of 2018. Yes, up 21 percent from May of 2018. All this despite record revenues. Receipts increased to US$232 billion, up 7 percent from the same month last year.

A rate cut would only create a larger problem in the future. If the already dangerous corporate and sovereign debt bubble expands significantly more, no monetary policy will prevent a debt crisis.

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PhD Economist and Fund Manager