The American economy is accelerating and the stock market is sitting at record highs. Yet some in Washington are still calling on the Federal Reserve to speed up the economy by slashing interest rates.
Top White House economic adviser Larry Kudlow on Friday cheered the first quarter’s 3.2% annualized growth rate as a “blowout number” that shows America’s economy is “clicking on all cylinders.”
But he hasn’t abandoned his call for the Fed to provide help by cutting borrowing rates — a step typically reserved for severe slowdowns or financial market scares.
Kudlow told CNBC that a deceleration in the Fed’s favorite inflation metric “could open the door” for a rate cut “in the months ahead.”
“The Fed is independent. I’m just expressing my view. The president happens to agree with that view,” Kudlow told the network.
To be clear, there were some signs of weakness in Friday’s first-quarter GDP numbers. But the rate cut talk is still puzzling some economists, who warn such a move would be premature — and could backfire.
“It doesn’t make sense to me,” Michael Gapen, head of US economics research at Barclays Capital, told CNN Business. “It’s odd we’re having this discussion with growth as strong as it is and labor markets as strong as they are.”
The Fed is low on ammo
America’s unemployment rate is sitting at 3.8%, a level near historic lows. And the S&P 500 and Nasdaq recently notched all-time highs, their first since last fall.
“It’s nonsense” to cut rates now, said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
Boockvar noted that despite the Fed’s rate hikes since late 2015, interest rates remain historically low. That leaves the US central bank with less room to maneuver when the next recession or financial market scare arrives.
“They barely have any bullets left. Let’s save it for when they really need it,” Boockvar said.
Even some of Kudlow’s former colleagues at CNBC were caught off guard by his comments.
“Larry, Larry, Larry — how can you be talking about a rate cut after a 3.2% GDP print for the first quarter?” asked CNBC anchor David Faber.
‘Soft’ underlying growth metrics
It would be fair to argue that the American economy isn’t as strong as the headline GDP figure suggests.
Underlying metrics on consumer spending were weak. And much of the growth came from a rise in business inventories — a trend that can quickly reverse, and which suggests companies are stockpiling goods instead of selling them.
“Strong headline with soft underbelly” is how RDQ Economics chief economist John Ryding summed it up.
But Kudlow didn’t make that point Friday. And his boss did nothing but praise the latest figures.
“We’re knocking it out of the park,” President Donald Trump told reporters after the GDP report was released.
Insurance rate cut?
Kudlow correctly pointed out that the Fed’s favorite inflation metric has decelerated from above 2% to 1.4%. That’s well below the central bank’s 2% goal.
“The inflation rate is coming down. The Federal Reserve will be looking at that,” Kudlow told CNBC.
The Fed has already sharply pivoted in response to the economic and financial turbulence that defined the end of last year. Central bank officials were forecasting three or even four rate hikes in 2019. Now they see none.
To be fair, the Fed has made precautionary rate cuts outside of downturns before.
In an interview with CNBC earlier this month, Fed Vice Chairman Richard Clarida recalled “insurance cuts” the central bank made in 1995 and 1998.
“Rate cuts are not always associated with recession,” Clarida added.
However, RDQ Economics’ Ryding pointed out that today’s environment is very different. Growth has not slowed as much as it did in 1994 to 1995. In fact, it has accelerated. And Ryding noted that inflation decelerated to just 0.8% in 1998, a year marked by severe market stress because of the implosion of hedge fund Long Term Capital Management.
Cutting rates today “would be premature and potentially a mistake,” Ryding added.
Asset bubbles, bold market revolt
One risk: Rate cuts could inflate financial markets, blowing the “big, fat, ugly bubble” that candidate Trump saw in 2016.
“You’re setting the stage for financial imbalances and overexuberance,” Barclays’ Gapen said.
Boockvar agreed, saying that the stock market is “the only thing you will goose with a rate cut.”
Another problem: Bond markets could revolt if the Fed cuts rates. If investors fear the Fed is being too dovish, long-term interest rates would rise sharply. That would lift borrowing costs and hurt growth.
“Fine-tuning rate cuts just potentially risks that (Fed) credibility,” Ryding said.
Perhaps talk of rate cuts from politicians in Washington should be taken with a grain of salt. After all, White House officials are nervously watching the latest polling numbers ahead of the 2020 election.
The Fed, on the other hand, has a dual mandate: maximum employment and price stability.
“Perhaps Mr. Kudlow has a different mandate,” Gapen said.
